The traditional annual budget process has been
widely and credibly criticized on many fronts,
but it stubbornly continues unchanged in many
organizations. It is hard to let go of the perception of
control that the annual budget provides. It is also a
game executives become skilled at, and they are loath
to trade away those skills and the probability of success
they feel they have.
Let’s consider the assumptions behind a traditional
“command and control” annual budget:
- A clear path to a target 12 months in the
future can be planned and then achieved.
- A plan remains a good measurement
point for 12 months.
- People respond consistently and rationally to
monetary incentives and penalties.
- Management is more knowledgeable about
products, operations, and customers than
responsible front line employees.
What’s the alternative? The adage—a failure to
plan is a plan to fail—rings loudly, and the 12-month
budget, despite its failings, is a plan.
The increasing volatility, uncertainty, complexity,
and ambiguity (VUCA) in the global business
and economic environment calls for more planning
and adapting than the traditional once-a-year
effort. Additionally, managers and workers
are demanding a higher level of trust and transparency,
and the flexibility to innovate and be
entrepreneurial. This workforce development is a
big positive for a VUCA business environment.
But how do we lead and manage it, particularly for
some level of financial control?
Revisiting the
budgeting process
A good first step is to simplify the goals and make
them more durable and long-term. For example,
a goal of sales growth at 110% of an established
sales growth index for your key markets. This type
of goal can last for several years, end contentious
internal arguments each year, and automatically
adjust to the macroeconomic environment.
Durable targets can also be set for quality, expense
control, operational improvement, etc. Durable
performance targets allow for longer term, more
realistic planning at all levels of the organization.
Budgets also typically involve an annual capital or
discretionary project component that pits all organizational
interests against one another in gladiatorial
combat for 12-month entitlements that then must
be used whether they are eventually needed or not.
Why not hold much more frequent discussions of
organizational performance and opportunities and
then invest based on the situation as it develops;
adaptations can then be made to meet the organization’s
long-term goals. This approach to investment
aligns with a shift to a flexible budget based on rolling
forecasts that show how well plans and goals are
being received in the market and achieved.
Performance and credibility
Individual performance tied to 12-month budgets
can lead to undesirable behavior in several ways—upfront negotiating for lowball targets, spending
that isn’t needed, uneconomic discounting, hard
selling customers, and even fraud. Furthermore,
it can cause dissatisfaction among employees who
see managers directing actions they know to be
questionable or even wrong. A move toward team based
performance incentives tied to durable,
long-term goals can foster more workforce innovation,
engagement, and positive problem solving.
It also makes the workforce more attuned to
organizational goals and performance metrics and
their part in contributing to them.
A final element of information to establish credibility
in the organization is to ensure that organizational
cost and investment measures reflect
the causal operational and customer (internal and
external) relationships that employees see in the
resources and processes they manage and work in.
Traditional financial accounting and reporting systems
are typically designed for creating regulated
financial reports for external investors, creditors,
and other stakeholders. New managerial costing
systems dedicated to creating internal decision
support information often need to be established
to create relevant information to guide the workforce
to focus on longer term goals. Without the
information to create understandable and internally
credible rolling forecasts and projections and
evaluate tangible and intangible investment opportunities,
the best intended workforce engagement
initiative can fail.
This article owes its inspiration and many of the
ideas to an article titled, The Guided Self-Control
Management Model, written by Franz Wirnsperger
and Klaus Moeller about their experience
at Hilti in the October 2021 issue of Strategic
Finance magazine published by the Institute of
Management Accountants.
