Effecting control
There are four key areas that need to be addressed;
Ownership
Measurement
Consequence
Forward Planning
Each of these elements is vital for continuity and successful budget control and should be used in a consistent manner. The main reasons why managers can lose control over budgets are around any of the above elements being missing or insufficiently followed through.
Quite often, the only aspect that is active is budget setting. Allocation, as you can see, involves the four key areas and is an ongoing process that builds a regular mode of behaviour, which helps people as much as it ensures your control.
How are people persuaded to take ownership?
Human nature dictates that when an organisation performs better than expectations there is no shortage of individuals to take a greater or lesser amount of the credit for the success.
When times are tough there is no shortage of individuals prepared to offer reasons “outside of their control” i.e. “they aren’t my budgets”, “I inherited a mess”, “it will take at least three terms in office to rectify the mistakes of the last board".
Sometimes these are quite legitimate, such as “things have changed since we set the budgets and I need to set new priorities” or “we need to spend more on this item to get a return on the money we have already put into it”.
Ownership can be as simple as a SIGNATURE.
However, asking someone to sign for ownership of a budget they have had no input into is tantamount to asking somebody to sign a letter they didn’t write.
Ownership is created through a process of communication and involvement. If the context has not been set at the outset then there can only be irritation at being ‘policed’ around it and it is common to hear managers say, “well, I am the decision maker and budget holder apparently but I’ve got no say in any of it. All I do is administer the decisions and report back on whether I’m being a ‘good boy/ girl’ or not.”
Equally, if ownership has not been established, how can we expect budget-spenders to take responsibility when circumstances change and consequences have to be confronted?
When preparing a budget, within the time constraints permitting, individuals should be asked to be part of the process, particularly around those elements they will be ultimately responsible for. Wherever possible there must be clear segregation of these areas of responsibility, in order to avoid subsequent ‘passing the buck’, finger-pointing and blaming bosses or peers.
For example, if three people are responsible for a budget item, then one may be hung out to dry by the other two in the event of non-performance, fairly or unfairly.
It’s simply a matter of survival and the fact is that money, along with status, is the most volatile issue in most organisations, yet we approach it in a clinical way, reducing organisational energy, ambitions and power to a set of figures on paper and then wonder why we do not control what happens afterwards as well as we would wish.
A not very sophisticated anecdote is that nearly everyone has grown up from childhood with someone else making decisions about how much money they can have to spend and to a degree, what they should spend it on. If you treat so-called responsible managers and budget holders in the same way, it will re-create old patterns of behaviour more often than not, regardless of how experienced, mature or skilled the adult individual may be.
If you are only able to create ownership through a signature, make sure their manager (maybe you) signs it off also, as in doing this the individual is not only being asked to take ownership of an area of the budget, but at least one other party is signing up to the sharing of direct responsibility and consistent monitoring of performance.
In order to ensure ownership, invite participation in the process, stimulate dialogue and then ask for formal acceptance, which includes specifying the ongoing monitoring agreements.
How is budget performance measured?
Actual results are normally compared to the original budget at monthly management or board meetings. It is often the case that variances are highlighted up to five or six weeks after the variance occurred and as a result remedial action is taken long afterwards.
Effective budget measurement needs to be carried out as close to ‘real time’ as possible andthat is why most organisations try to prepare daily, weekly, and monthly KPI’s (Key Performance Indicators) that are the safety net for any management activity. Unfortunately, this level of monitoring only tends to happen in crisis situations when the cash flow, for example, is seriously threatened or when sales have taken a dive.
These KPI measures, by their nature, are designed to focus on the key areas that materially affect the achievement of an individual and organisation’s targeted goals.
They should be readily accessible and presented in a form that is easily interpreted and understood and the selection of which KPI to use and how often to report on them is a key aspect of the ‘creating ownership’ process as described above.
As the best form of measurement is that closest to ‘real time’ events, you need to have some sort of system that ‘turns the headlights on’ and allows everyone to see what’s coming rather than reporting on what was under or over budget after the event, which can only reduce the matter to recriminations and panic.
KPI feedback should be distributed to the individual responsible for the delegated budget and their immediate superior as well as other departments impacted by positive or negative variances, in a timely fashion.
For example
The budget KPI may relate, say, to ‘installing new computers’ but the area involved may be showing a downturn in the sales trends or capacity utilisation that won’t show up in the management accounts for a couple of months (by then the computers will have been bought) and in which case, you need to review and address the situation. This doesn’t mean you necessarily forego the new computers, it means you re-engage with the budget holders and include them in the review, which may result in reallocation of funds, especially if the new computers are critical to reversing the sales trend.
The key is to allocate budgets and their KPI so that you have a built-in set of options based on scenarios that say ‘if this, then that’.
Again, a set of figures that reflect the two-dimensional setting aside for funds against future events that haven’t happened yet is highly unreal and you might as well expect to reach your destination simply because you’ve brought the road map and turned on the ignition of the car.
However, most highly regulated companies are doing just that by the ritual of setting annual budgets. Whereas it is easier to administer and some items must be set annually, the short-term ease created by the process is more than obliterated by the ongoing inflexibility and ‘one-track’ management of the organisation’s financial health.
The extreme opposite of this is ‘zero budgeting’ which means that spending decisions are made monthly for all variable costs and are based on what has happened the month before, in performance terms.
In either situation, the key is to involve all key parties and to build in flexibility against the longer term decisions.
What is a KPI?
The KPI can be as simple in the first instance of a graph of the cumulative daily turnover budgeted, displayed against the actual turnover achieved, above the budget line = success, below = failure.
In the second instance the KPI can be as simple as a graph of the cumulative turnover budgeted against physical orders received for delivery in the following twelve weeks.
Above the line = success, below the budget line = the NTC (need for orders to be created).
Variations may affect other departments, who need to respond to these KPI. Visibility of variances on the forward order book in a manufacturing environment affect the creation or reduction in resources and will allow the production manager to maintain his gross margins by avoiding overtime through recruitment and idle time through redundancy or rescheduling.
Those KPI that materially affect the organisation or business unit as a whole should be publicly displayed.
In summary, KPI measurement must be constant, linked to ‘real time’ events and enable a response within a short period of time, communicated to all affected parties.
Understanding the consequences
Exceeding budgetary expectations as well as failing to meet them will result in consequences to the organisation as a whole as well as to the individual. It is therefore very important that these consequences are understood at the time an individual takes ownership of part of the overall budget and that they have confirmed their understanding directly and overtly.
This can be done by including key parties at the outset and then presenting the budget to the organisation on a department by department basis (involving those key individuals) showing the overall affects on the organisation as a result of either success or failure.
As well as understanding the consequences to the organisation, the individuals also need to understand the consequences to them.
Whether an organisation follows a carrot or stick approach, if an individual can see tangible positive or negative consequences to his or herself as a result of over or under-performance, this helps enormously to focus them on their individual goals.
It has been proven time and time again that the more clarity an individual has about what is expected of them the more likely they are to succeed. However, if the process is not done as a consistent and regular mode of business, people will constantly feel that the ‘goal posts are being moved’ or that it really doesn’t matter anyway because others will make the decisions whatever is done or not done to make the job work.
Where achievement of budget requires a team performance, then earning incentives can be based in proportions; split between their performance as an individual and the overall performance of the team.
The resultant peer group pressure and exchange is extremely effective and a positive force at the level of culture, as people are ultimately motivated by a number of things, such as making a contribution and acknowledgement and money is just one aspect, albeit an important one.
At the time of ‘creating ownership’ ensure the individual and team understands both the positive and negative consequences of future budget and business performance, to themselves and to the organisation as a whole, so there are few arguments when those consequences are later felt.
The need for forward planning
Much of this aspect has been covered in the above points, especially relating to flexibility and options with real time reviews that allow for swift and effective responses… but what happens when ‘it’s too late’?
Exceeding budgetary performance can have as devastating an effect to an organisation as under-performance. Overtrading can lead to sales order backlogs if the organisation's overall capacity has been breached, or even increased working capital requirements.
It is therefore advisable to prepare rolling forecasts on a quarterly basis evaluating the next three months and following three quarters which reflect the effects of the ongoing variances on the organisation as a whole.
These must then be debated and changes made to the way the business operated to maximise or minimise the positive or negative benefits.
It is an essential part of budgetary control to consistently re-evaluate the effect on the overall business as a result of these budgetary variances. In other words, no matter how much forward planning is built into the system, it may not be enough and circumstances may require radical action or the budget holder may be ignoring the process and ground rules agreed at the outset.
If the latter is the case, it is either because the person does not grasp the process or they did not agree to it, in truth, at the point of creating ownership. Either way, this particular issue is very difficult to address in an objective manner because of the impact that an individual has had on the whole business. It can become unpleasant and even ‘personal’ when the facts are confronted.
The key point here is to look out for signs of non-conformance as early on as possible and address it then. If someone is late filing reports, doesn’t come to review meetings or consistently shows variances against budgets, you must act even if the items are non-critical at that stage. Find out the real reason and either strengthen the support and control needed or put the person into a different realm of responsibility.
Nine times out of ten, when managers rage against something their people have done or not done, it will be because they themselves ‘took their eye off the ball’ or were inconsistent in their involvement with the budget holders … sometimes it simply means they didn’t read the reports properly when the initial signs began to show.