Improving Strategy Execution through Effective Budgeting

October 5, 2012 6:51 am 0 comments Views:

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Budgeting is nearly always portrayed as a management process that helps an organisation  to execute strategy.  Fine words indeed, but how many budgets and associated budget processes actually support that ideal?  Surveys reveal the reality that most budgets are totally disconnected from strategy and that the resources essential to success are often missing or unavailable.  In this short, practical article based on the best practices of high-performing companies, we show you how to design a budget process that will directly improve strategy execution.

What’s the point of the budget?

It comes as no surprise that budgeting is one of the most time-consuming management processes that seem to add very little to improving strategy execution.  Instead budgeting is often seen as an elaborate numbers guessing game in which the players - both senior and operational managers - try to hide or out maneuver each other.  Too make matters worse; the people who play the best game (or who are just plain lucky) are rewarded through ‘incentives’ and bonuses.  The result is a process that is not only adds little value but also damages organizational strategy.

Now none of this information is new and ‘bad practice’ strategy is often enshrined within organizational folklore, so why is this ineffective management process allowed to continue?  Over the years many management methodologies have sought to put things right with the Beyond Budgeting movement being one of the more vocal, and yet very few organisations seem ‘brave’ enough to change the status quo.

Budgeting has the potential to be one of the most productive and essential management activities in implementing strategy.  Through it management can ensure that key strategic initiatives essential for success are properly resourced and can be implemented in agreed timescales.  Once set, the budgeting system can then go on to warn if those activities are behind schedule; are not achieving the success envisaged; and can be used to safely allocate or redistribute resources to put plans back on track.

However, this can only be achieved if the budget content, process and supporting systems have been set up to focus on strategy, as we will explain in the rest of this article.

 Aligning budget content with Strategy

Take a look at the content of any budget and it is more than likely to be based on the organisation’s chart of accounts.  Similarly, the hierarchy will be based around cost centres and the timescale will be months or set periods within a year.

If this is the case then this is exactly the same setup that was used in the 1920′s as defined in the book ‘Budgetary Control’ by James McKinsey.  It’s hard for organisations to break away from this ‘design’ as it mimics the general ledger, which is often the source of reporting actual results.  The only issue is that this design has no link to strategy other than monitoring the financial outcomes of strategy.  To ‘manage’ strategy we need a different design and additional information.

At the heart of a budget model designed for today’s business environment is a set of relationships that show how the organisation generates value.  It will describe the activities involved and how these link the different departments together.  These activities will typically focus on how revenue is generated; how products/services are developed; how customers are maintained; how the organisation maintains relationships with suppliers; and how corporate governance is assured.  These activities will be different for each industry but together describe how the organisation operates today.  Measures involved can often be set up as a driver-based model where entering a figure such as the number of sales calls can then be used to generate sales contracts and revenue, based on assumptions of results achieved in the past.

This model has a separate ‘budget’ dimension that is used to collect the resources required for each department involved.  These can be based on forecasts and previous actual results, which when consolidated form a budget for ‘Business as usual’.

Alongside this budget is a second budget where strategic initiatives are separately resourced.  Most strategies consist of initiatives on how the ‘business as usual’ model can be improved.  For example, initiatives to improve sales performance; launching new products into new territories; or ways of streamlining production.  For each of these initiatives (usually agreed as part of the tactical planning process), departments set a separate budget for their implementation.  As well as resources, measures are also be set for the year to assess the status implementation, and the success each initiative is expected to have on performance of the business model.  These measures of implementation and success can be used to determine the level and timing of resources required and to later assess whether the initiative is ‘worth it’.

These two budgets - business as usual and strategic initiatives - can then be combined to give the total budget.  Doing it this way can help with budget reviews. Should revenues be too low or costs too high, a sensible discussion can be had around which initiatives are to change or lose, rather than go for an unjustifiable ‘reduce all figures by x%’.

Aligning the budget process with strategy

Budgeting is typically seen as an annual exercise lasting 3 to 4 months that is typically out of date within the first quarter.  This isn’t surprising given the pace of change within today’s business environment.  In fact the concept of annual budgeting, quarterly forecasting and monthly reporting were all established in the 1920′s as mentioned earlier, when the world was a very different place.

What is required is a budget process that is in tune with strategy.  I.e. anytime key measures within the plan deviates by an agreed amount, there should be an automatic trigger to review and if necessary re-plan the affected parts.  These key measures could include summary costs and revenues by major product/geographic area; key assumptions on the business environment; unexpected competitor/customer/market changes that have the ability to significantly change the future.

This means collecting forecast figures and key performance indicators, as well as the actual resources used.  This data then needs to be analyzed and assessments made as to whether the ‘business as usual model’ is accurate; whether strategic initiatives are being implemented; and whether the costs involved are worth the results being produced.

The budget/reporting process itself should be ‘continuous’.  It may start out by first collecting ‘business as usual’ budgets and assessing whether the results forecast by the driver-based model are realistic based on past performance.  When we say that this activity is ‘first’, it also should be a continuous activity that happens throughout the year, with the ‘budget’ for future periods being continually revised and updated.

Once the ‘business as usual’ figures are established, then the impact of strategy can be overlaid through the budgeting of strategic initiatives.  These initiatives can be considered to be projects that have a defined life cycle and associated resources.  There is no reason why this set of initiatives could also be assessed, cancelled or redeveloped on a continuous basis.  The funding of these will come from a separate budget that can be increased or cut as conditions dictate.  But it needs to work in conjunction with the ‘business as usual’ budget to give the full resource picture.

As mentioned earlier, as well as regular reporting on the accuracy and impact of the two budgets, there also needs to be mechanism that will trigger reviews or re-plans based on exceptions, events as well as a date on the calendar.

 Choosing budget solutions to improve strategy execution

Quite often, the content and processes for budgeting are dictated by the software being used.  With today’s technology solutions, it should be the software that supports the organisation and not the other way around.

When looking for budgeting solutions many people still look to capabilities that massage numbers.  Capabilities such as ‘top down spreading’, ‘phasing’, ‘goal-setting’, ‘slice and dice’ and ‘drill-thru’ but do these really support strategy execution?

For a solution to do this then a number of key capabilities are essential, including:

The budget model must support driver-based planning where organizational activities can be linked as a ’cause and effect’ model

It must be possible to overlay the business model with strategic initiatives that show how ‘business as usual’ can be improved.

Budgets should be displayed as financial statements as well as strategy maps that show how organizational performance is affected by the allocation of specific resources

Must be able to highlight where activities are not being carried out their impact on overall goals

Must be possible to show how effective budgets have been in achieving performance improvements so that changes can be made as necessary

Must support continuous planning by automatically triggering reviews and/or replans through exceptions, events, as well as dates on a calendar

Must be able to track the life of a plan - the changes made by who, when, the reason why, and how those changes have impacted overall results

These capabilities are typically not found in older systems that were designed to support the 1920′s view of budgeting.  For more detail on emerging systems designed for today’s volatile environment, check out our paper of “Performance Management Frameworks’.

By Michael Coveney, EPM Contributor, from:

Michael Coveney has more than 35 years of experience in the financial analytic software industry, helping enterprises combine ‘best management practices’ with technology to improve the efficiency and effectiveness of their performance management processes.His energetic style and insightful views has led him to become a regular speaker at international events, a course leader with the Antwerp Management School, and the author of many articles and books including his latest ‘Strategy to the Max’ – a down to earth look at all you need to know in setting up systems that support the implementation of corporate strategy.


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