Budgeting

In over 25 years as a senior executive in a Fortune 500 corporation, I participated in all aspects of the budgeting process in departments, divisions, different countries and cultures, and separate corporate entities. I developed, discussed, reviewed, approved, executed, and quarterly and yearly, assessed performance against budgets.

Many folks had difficulty with budgeting, which I wrote about previously. I referred to their challenges as the DAVID effect: denial of the need; wanting to escape accountability; adopting the victim approach of blaming others for their performance; ignorant, not wanting to learn; and claiming a lack of discipline to stick to the task.

Once folks overcame their difficulties, still, they had problems sticking to the budget. Over the years, I found three significant reasons for this, which I regarded as the LIP budgeting way to be avoided.

1. Lack of commitment
2. Inflexible budgets
3. Performance not linked to outcome

Lack of Commitment

People understood the need to budget. They knew the budget was their road map guiding them to goals using scarce corporate resources. They knew when they stayed with the process; they saw positive results. Even so, they found it difficult to commit to the journey.

Several reasons caused their lack of commitment, but two predominated. First, people felt excluded from key parts of the budgeting process, such as discussing assumptions, and setting specific interim targets. Second, they felt insufficiently empowered to act when they saw areas needing attention.

When we dealt with those two conditions, folks owned the process, stayed with it, and we got results.

Inflexible Budgets

We had to teach managers how to manage performance and work with a budget. We stressed that we would never revise the budget to cover up poor, sub optimal performance. We wanted to ensure they used resources effectively to benefit the company from unforeseen, but available opportunities. Sometimes they had to trade off overspending one area to optimize and create value in another.

This was a tough lesson to convey. However, in the budgeting process, we built "what-if" scenarios and prioritized them according to strategic importance. When conditions changed during the budget period, managers had action plans available that they could implement quickly by diverting resources. For example, managers prepared action plans to use two essential complimentary raw materials under different price scenarios. If the price of one spiked, or plummeted, department managers, had available scenarios to allow them to cut the quantity of one and increase the other to maximize value creation in the period.

The most difficult idea to communicate was that a flexible budget had just one meaning. We changed the budget when conditions changed, to seize opportunities to create value; only then was the budget variable. Once managers bought this, their performance shot up.

Performance Not Linked To Budgets

This was complex. Financial budgets were only one part of the manager's performance targets. We needed to ensure that the link between compensation and budget results was not so exclusive that it encouraged games with the numbers. Customer service, product quality, morale, and other softer measures were vital. Still, we argued that these soft measures, ultimately, drove overall budgetary performance.

The challenge was how to use the financial budget target as the critical performance measure over time, while stressing the importance of non monetary targets. We did this by regular, simple, monthly and quarterly reviews, and routine individual performance appraisal sessions. A key part of this review process was managing by "walking about." We visited locations regularly, spoke with different organizational levels, toured operations, and made ourselves accessible. It worked!

Summary

A successful business needs a strong flexible budget culture. However, the business must stress that the budget is not a straitjacket, but a road map to a destination. On this journey, when conditions change, managers must be flexible and take full advantage of changed circumstances. Therefore, businesses must train, develop, empower, and reward managers to seize opportunities; even those which might cause over spending today to create significant value tomorrow.