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Why Budget?
Ask any three people in an organization why they budget and you are bound to get three different answers. They usually include such statements as, "It is something we do every year," "It is a big stick we use to cane those who don't perform," and "It is the mechanism for setting the managers' bonuses." Is this really the intended purpose of budgeting? Consider the typical budgeting cycle. It lasts four months-up to 25,000 person-days per year for the average billion-dollar company1-and starts with senior managers asking the rest of the organization to "guess" the financial numbers that they already hold for next year. That guessing is facilitated by a set of spreadsheets that are handed out to budget managers for completion. Once completed, the spreadsheets are returned and numbers are consolidated, only to reveal that the budget managers' guesses weren't right.
So the second round starts with senior managers asking budget managers to guess again. This time, the budget managers are now focused on what set of numbers senior managers hold and whether they can guess the right ones. Strategy-the "how" of achieving the numbers-has been replaced by a numbers guessing game. If the organization is fortunate, then senior managers will reveal their guess by doing a top-down pass to the budget holders-who now have a great excuse for missing the budget: it wasn't their guess.
With this type of process in place, it is no wonder, then, that no one says they budget in order to direct the way in which their organization will achieve its strategic goals-the intended purpose of the budget. According to data cited by Kaplan and Norton, creators of the Balanced Scorecard, 60 percent of organizations do not link strategy to their budgets. For budgeting to become the relevant process it was meant to be and can be, this gap must be fixed.
The Role of Budgeting in Performance Management
The budget is similar to a car's gearbox: it doesn't work in isolation. A gearbox's function is to transfer the power of an engine to a chassis so that the driver can move towards a predetermined destination. If the gearbox is designed without reference to the engine that will power it, the car won't work and the driver won't go anywhere. Similarly, if a budget is designed without reference to the strategies it is supposed to support and the resources available, the corporation will not move towards its desired goals.
Budgeting is part of a larger, closed-loop process called "performance management." Performance management is a holistic approach to the way organizations direct and manage resources to achieve objectives. In the context of performance management, budgeting's central role is to support execution through the allocation of resources to the activities that drive value. Jack Welch suggests that budgeting can be a productive and "wide-ranging, anything-goes dialogue between the field and headquarters about opportunities and obstacles in the real world" if organizations concentrate on two questions: "How can we beat last year's performance?" and "What is our competition doing, and how can we beat them?"
The answers to these key questions typically appear in a strategic or operational plan, against which budgets can be set and monitored for effectiveness. But if that plan is vague or incomplete, the resulting budget will not help the organization implement its strategy.
Best Practices in Strategic and Operational Planning
Most organizations have plans. There is, however, a huge difference between a good plan and a bad plan. A bad plan, for example, is one that consists only of costs and revenues. This plan provides no guidance for the organization regarding how it is to achieve the revenue targets. There is no linkage between the high-level goals and the day-to-day activities necessary to achieve them.
Performance management is all about managing the activities that generate results. Those activities should directly support the organization's strategic objectives. Therefore, a good plan acts as a road map, showing the organization how it should move from its current level of performance to the desired level of performance, based on the perceived economic environment. The plan accounts for the activities, dependencies, assumptions, time scales, and resources necessary to support an overall strategic objective.
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