Is It Time to Replace Traditional Budgeting?

Article excerpt

A method to make a budget more useful to management is proposed. large company, frustrated by years of continual growth in real operating costs (despite severe margin pressures), decided to examine the effectiveness of its budgeting process. It was stunned by its findings:

* Budgeting consumed the better part of the year and involved several hundred staff and line people.

* Budgeting weakened strategic resolve. Staff became preoccupied with budgeting mechanics rather than with strategic issues. Senior management confessed it could not relate budgeted expenses to the strategic plan.

* Participants tended to focus on incremental costs, taking for granted costs embedded in the previous year's budget.

* The budget structure did not reflect changes in the company's organization and processes, and people were budgeting many costs largely under someone else's control.

* Budgets were not credible.

Research done by my consulting firm supports this company's experience. In a study of 10 large energy, transportation and banking companies, we found that, on average, the equivalent of 5% of all staff employees were devoted full-time to budgeting activities.

THE REAL COST OF BUDGETING

For a better idea of the real cost of budget preparation, consider this: At one of those 10 companies, which has a staff-support team of 3,000 employees, 160 employees devote time to some aspect of budgeting. At an average cost of approximately $105,000 per employee, the company s annual cost of budgeting is nearly $17 million--which does not include costs of services supporting the budgeting activity: computer operations, software maintenance and benefits administration for these employees. The full cost of budgeting may exceed $20 million a year.

For that kind of money, budgeting should yield accurate expense forecasts, provide effective support for decision making and control and employ efficient development and reporting processes. In fact, in most cases it fails to do those things.

Conventional budgeting fails to prevent the growth of uncompetitive cost structures in many companies. Evidence for that failure is sweeping corporate America--massive capital restructuring, organizational consolidations and staff cutbacks. This article describes one way to achieve effective resource allocation and control by replacing conventional budgeting processes. The technique is called multidimensional budgeting (MDB), which converts conventional budgets into formats that are more relevant to management. For the purposes of this article, that conversion is called a transformation, in which the data is reformatted into four separate but related budgets: an activity budget, a product budget, a customer budget and a strategic budget.

Properly applied, MDB yields tremendous insights into resource use effectiveness and enables management to align resources with corporate strategies and customer needs. MDB translates into higher profitability and an improved competitive position.

MDB can supplement conventional budgeting with a powerful new set of resource-allocation and decision*support tools. It focuses on the relationships between spending and the underlying value created, rather than on merely how budgeted funds are spent.

The outline for a typical multidimensional budget is illustrated in exhibit 1, page 106. As the reader will see, once the new budget is developed, management can assess resource allocations by working down from the strategic budget to the base conventional budget. At each level, management can test the correct alignment of resources against its priorities, and the budget can be adjusted, as necessary, until an optimal statement is achieved.

FIRST TRANSFORMATION: ACTIVITY BUDGET

The first step is to convert, or transform, the conventional budget into an activity budget, which discloses how much the company spends on specific tasks and the types of resources it devotes to them. …