When is a budget not a budget?
| by Brian Rutherford 03 Nov 2000 Diploma in Financial Management Relevant to All Papers |
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A “cultural revolution” for budgets?
A number of large multinationals have recently been reported as having “scrapped” their budgets. Budgets are said to be a major barrier - sometimes, indeed, the major barrier - to success in a knowledge-based economy. Even new approaches such as activity-based budgeting must be swept aside if enterprise is to thrive. Managers must be liberated from the straghtjacket of annual beancounting rituals and empowered, with a mission to “beat the competition not the budget”.
So what does “managing without a budget” involve? One company that abandoned the annual budget process in 1994 is reported to have replaced it with:
- monthly, three month ahead, forecasts;
- monthly out-turn reports with key performance indicators;
- two year ahead rolling forecasts, updated three monthly;
- four year strategic plans, revised annually; and
- 10 year strategic plans, revised annually.
So, no bureaucratic straightjacket there, then.
On the face of it, abolishing the budget seems to be a matter of ensuring that no document that has financial captions down the left hand side and periods across the top also has the word “budget” anywhere on the page - call it a forecast, a target, a forward look or a summary of the strategic plan and, hey presto, you’ve abolished the budget! But there is more to it than that. The burden imposed by a system is not necessarily easily inferred from a bare description of it and the sort of elaborate information flows prescribed in the list given in the previous paragraph may well be easier to manage and impose less of a burden than the simple but demanding regime of the traditional budget.
Furthermore it may well be that the new system provides better information for planning, motivating, steering the business, evaluating performance and beating the competition. It has to be admitted that there is a lot wrong with budgeting, as traditionally conducted, from all these angles and it doesn’t take much imagination to suggest improvements though it can take a great deal of imagination to envision what the new system will look like and a great deal of courage to make the leap from “tried and understood” to “new and innovative”.
The question I want to raise is whether the rhetoric of budgetary “slash and burn” is either appropriate to what is going on or helpful.
The problems that arise in selling an annual plan and expecting it to unfold without hesitation or deviation over the ensuing 12 months have been known and understood for decades. Early responses to these problems included the concept of flexing the budget and it is, indeed, depressing how little even this modest innovation has been taken up in practice - no doubt partly for fear that it will be used as an excuse for underperformance. Other responses included rolling budgets, updated quarterly or monthly. The motivational side of budgeting, including the need to set “stretch” budgets, has also been much discussed.
Although the extent to which these developments have been implemented is limited, this does not demonstrate that budgeting needs to be abolished - only that more imagination, energy and courage needs to go into developing and designing planning and control systems to suit the 2000s and beyond. We already know a good deal about what goes wrong (and what goes right) in budgeting and it is unnecessary - and expensive - to abandon all this knowledge in pursuit of a “cultural revolution”.
Knowledge-based economy
For example, it is often suggested that the new cultural revolution
is needed because the world of manufacturing has been replaced
by a knowledge-based economy. Many knowledge-based resources,
such as intellectual property, brands and loyal customer bases,
do lie outside traditional accounting measurement systems, but
there is no reason why they have to. Knowledge is a resource and
we have a great deal of experience in using budgets to manage
resources (and some businesses, such as drug companies, have been
in knowledge-based sectors and used budgets for decades). We should
first examine carefully what lessons we can learn from this accumulated
experience before we abandon it too lightly.
Again, a “budget-less” management system advocated in some quarters is the Handelsbanken model, which employs relative targets: each branch of the bank competes with all other branches via league tables drawn up on the basis of key performance targets. It is claimed that, under this system, the targets are always up-to-date, always tightening, and strongly motivating because of peer pressure. The first problem with the Handelsbanken model is that the system requires that the organisation is composed of large numbers of homogeneous units - true of banks and, perhaps, retail stores, but of almost no other type of organisation. Using external comparators introduces all the problems of benchmarking - widely recognised as an extremely useful source of insights but not necessarily of targets, Further even if an organisation that is composed of the right sort of units, the system can work only if the organisational culture is appropraite. If not, branch managers will quickly realise what production line staff have known for many years, that by co-operative action and social sanctions, a group can control the targets their managers believe they are setting with enormous cunning. We need to remind ourselves of the Hawthorne experiments of 1927-1932 a massive set of studies of behavionial modification that demonstrated, among many other things, how groups control “rate-busting”. A simple example here of a lesson learnt and understood three-quarters of a century ago that might all too easily be forgotten in the new cultural revolution.
lncidentally, internal competition under the Handelsbanken model might be thought to be divisive and likely to lead to turf wars, charges often levelled against traditional budgeting by the advocates of its overthrow. Proponents of the Handelsbanken model argue, however, that it is free of these vices because a strongly supportive culture encourages co-operation and the spread of best practice. But if culture can overcome the potential divisiveness of internal competition, surely it can overcome the same problem under traditional budgeting?
Fortunately, much of the apparently revolutionary and abolitionist literature and practice is in fact evolutionary, developing better solutions from what has gone before. The range of quasi-budgets replacing “one true budget” in the example given above demonstrates this.
There are advantages to the presentation of the changes as a cultural revolution. Some are real: it emphasises management commitment to the new way of working and provides an opportunity to throw out more of the baggage that goes with systems than perhaps could be accomplished with an overtly evolutionary approach. Some are less real: it no doubt impresses the shareholders, but for how long?
A potentially serious consequence of the revolutionary facade, viewed from the point of view of the accounting profession as a whole, is that it can discourage companies, particularly small and medium-sized enterprises, from reaping the advantages to be gained from developing a more sophisticated approach to budgeting because they believe they must throw out everything and start again - a far more expensive, and risky, move than is really necessary. Thus, whole areas of the economy are cut off from a potentially useful development.
The last slash and burn management fad to dominate the headlines was down-sizing. We now know that this was a potentially dangerous cult that could easily lead to “corporate anorexia”. Strategic financial managers need to be careful that the same mistake is not made with the budget.