Alternatives to Budgetary Control

Alternatives to budgetary control Contents Introduction Critique It takes time and effort Floors and ceilings Centralised structures are no more Tardiness Incrementality False accounting periods Why do we budget? What can replace budgets? Quarterly strategic reviews Balanced scorecard ABC and ABM Conclusion If you need my Home page or Site map Introduction Budgetary control is regarded as an important aspect in managing resources in general and cash in particular. In our personal lives, we set a budget to ensure that the competing household interests for our earnings are satisfied whilst not exceeding that earnings capacity. Surely it’s the same for corporations? This paper provides a critique of budgetary control and suggests some alternatives. Back to Contents Critique It takes time and effort If you look at most public companies that employ budgetary control, they aim to complete the process in time for the start of the new financial year, however on average it takes the business about 90 days to complete the iterative process that is setting a budget. Since cost centre managers need to have buy-in for all of the numbers in the budget, the process takes up significant operational management time as well as the time of accountants. With all of this internal cost, corporations must see a significant benefit for this annual investment. Floors and ceilings Unfortunately, budgetary control, like most management tools, creates a form of behaviour. In the case of budgetary control it creates a floor for your costs and a ceiling for your sales:  How many times do we hear managers spending their budget because “they don’t want to lose it next year”. Where managers work on the principle that if they don’t spend their budget they don’t need it and it will be taken away, it is a natural behaviour for the manager to protect their position because next year, having lost the budget, they may need it  When a sales person hits a target, how many times do they take their foot of the pedal and disappear to the golf course? Many sales incentive schemes put ceilings on the earnings of their sales staff and this inhibits their craft, so surely it’s in the interests of the organisation not to limit earnings capacity? Centralised structure are no more Budgetary control is a creature of the command and control approach to management. It comes from a time where a corporate HQ needed to ensure that it could control its subsidiaries and measure their performance. Definitely, it’s the type of device that would be used in the conglomerates typical of the 1970’s that are now no more. In today’s world, there are different corporate structures. These ones do not use command and control because they assume that autonomous managers know their customers better than HQ and therefore respond to customer requirements quickly, some call these “empowered” organisations. By imposing command and control procedures on autonomous managers simply reduces their capacity to respond to the changing external environment, leaving their business exposed to nimbler competitors. Tardiness As indicated in the section on the time that it takes to complete budget iterations, the job is intended to be complete before the start of the year. However once the year has started, the capacity for managers to produce the business suggested by a budget becomes increasingly diminished as the financial year moves forward: the budget is out of date. So, what is the point of having a device in place that does not reflect what is happening in the real world? Proponents of budgetary control will counter this argument by saying that budgets can be flexed or changed periodically by going through the whole process again (all 90 days?) and calling it a forecast. Elsewhere on this website (financial planning) I propose a monthly forecasting process, but in the wider consideration of the value of budgets, even that is questionable. Incrementality In preparing a budget, what really happens? Take last year and add a bit. In fact in that financial planning page, I propose that a “side-to-side” approach is taken as well as a top-down and a bottom-up approach. This means that you are following on from last year to ensure that this coming year is consistent with last year by “adding a bit”. Is that the basis for a challenging approach to running a business? An alternative to the incremental approach to budgeting is a concept known as “zero- based budgeting” or ZBB. The concept behind this idea is that you assume that a business does nothing and so has no cost (hence ZBB) and then in order to meet the external demands made on the business, cost is identified and included in the budget. Unfortunately, this probably takes even more time than the 90 days that it takes the average FTSE100 business suggested above. Accounting periods This idea forms part of a wider criticism that budgetary control is a purely financial devise rather than a business control. Accountants conveniently divide a 12-month period into months, whether that is a calendar month, a lunar month or 4-4-5 months. And of course they start with this 12-month year in the first place. How many business cycles actually work to these convenient measures of time? Very few, I would argue, particularly since accounting has invented with something called the accruals concept to deal with economic events whose associated transactions fall in a period that is different to the economic event in itself. These arguments suggest that budgetary control is strategically naïve, operationally misleading, a huge input of effort, and effort that only “adds a bit” and really, it’s all about financial and not business control and giving the accountants a job. Back to Contents So why is it done? Good question. Probably the best answer to this is that one of the uses of budgetary control is that enables a business to allocate resources between activities easily and to hold the managers entrusted to those resources to account. Its back to the housekeeping money that this paper started with. All organisations have to hold their managers to account for the resources entrusted to them; shareholders do this with the Board of Directors (although notice that this is not done with a budget!) so it follows that the Board should do this with its senior managers and the rest of the corporate hierarchy. In criticising budgetary control to the extent that it is scrapped, any structure that is brought in place needs to ensure that the organisation’s managers are made accountable. Back to Contents What can replace budgets There are a number of devices that can be employed, however whether it is right for an organisation to scrap budgetary control in favour of any combination of the following needs to be considered very carefully. Some organisations have taken the plunge, for example Diageo, so it is possible. Quarterly strategic reviews This device counters many of the arguments against budgetary control. A strategic review looks at all aspects of the business, not just its finance, and that review will produce the rolling forecast that is proposed under the “tardiness” criticism above. In addition, it links operational imperatives with strategic imperatives and it enables an organisation with a devolved structure, rather than a command and control structure, that flexibility. By making reviews as frequently as quarterly and as infrequently as monthly, a balance can be struck on the amount of time that is taken to prepare the numbers (bearing in mind that you are saving on average 90 days) and there is less risk that the forecast will suffer the other fate of the budget, tardiness. Balanced scorecard This is covered in more detail elsewhere, however suffice it to say that by using this reporting technique, the organisation has a strategic record of its direction, both past and future, for those at the centre to measure what’s going on. One of the main advantages of this technique is that it has a capability to measure the only thing that has been proven to represent future strategic success – reputation. It measures reputation in respect of staff as well as reputation in respect of customers and in today’s service-orientated business models, both of these are equally as important. Of course, the measurement of reputation is not something that can be done by using numbers and may not be so easy to measure, but since they are forward-looking measures of success, they should be a more accurate reflection of what is about to happen than a series of numbers. It is not a device that replaces management accounts very successfully (some argue that it does) as it is really a change management record, so its implementation needs to be considered properly before implementation Activity-based costing and activity-based management This is another device that can provide accountability in the system: in fact the whole idea of this is to say “what are the drivers of cost and which managers are responsible for those drivers?”. There is a criticism of ABC and ABM in that it can take a whole bureaucracy to identify the drivers, set the standards and to measure what’s happening, although it is possible to employ these techniques to varying degrees of complexity, dependant on the strategy of the business. Conclusion These suggestions for the replacement of budgets have a common theme: budgets operate at a financial level, these techniques operate at a strategic level. Care has to be taken in implementing them, in particular in ensuring that accountability, the real strength of budgetary control, is maintained. Any movement over to these alternative measures will surely change the culture of the organisation and that change management process has to be carefully managed. Back to Contents