Annual Budgeting as a Management Tool
Robert Loeb and Michael Workman
This is the first in a series of articles introducing budgeting as a management tool. When properly executed, the budgeting process can assist with planning, organizing, staffing, leading, and control. The process can help managers to effectively communicate and implement goals and objectives throughout the firm.
One of the greatest challenges for business owners is to make the move from business operator to business manager. Budgeting is a crucial step in making that transition. Peter Drucker is attributed with saying, “ If you can’t measure it, you can’t manage it.” Not only does budgeting help establish measures and controls, but it also helps create circumstances that better allow tasks to be delegated effectively to other members of the organization.
Overview of Annual Budgeting Process
Annual budgets are well known financial tools. Creating the annual budget is a multi-step process that should involve many people in the organization. Non-financial people involved in the budgeting process normally need some financial training to help maximize their effectiveness in budgeting. Over time, participants become more comfortable with the budgeting process and strive to improve its effectiveness.
Annual budgeting has four broad stages. The first is information gathering; where past performance results are collected, the company’s strategic plan is considered (if one exists), corporate goals and objectives are included, and the overall market environment is evaluated. Customers often are contacted during this stage to assess their satisfaction with service levels and to obtain forecasts of future business plans.
The second stage is planning where determinations are made as to the amount of detail to be included and how the budget will be presented. Determining the level of detail needed and communicated is critical to the success of the process. For example, will revenues be budgeted generically, or broken down by product groups? Often companies do detailed department budgets that are then rolled into a summary budget for senior management. Finalizing budget assumptions is also critical in this planning stage (see section below on assumptions).
The third stage involves actual budget preparation. All the information obtained in the first two stages is put into numbers, and financial projections are made for revenues, expenses and capital spending.
The final aspect of budgeting is control. Throughout the year actual results are recorded and compared to budget (or the standard). Variances from budget are noted, evaluated and explained, often by operations people. This aids in the company’s ability to initiate preventive or corrective actions.
Effective decision-making occurs in an objective environment where managers can consider alternatives and make decisions within the context of other decisions. The budgeting process provides a structured environment to facilitate decision-making, and is far superior to any form of reactionary methods such as crisis management. Budgeting decisions are not set in stone, and may be modified throughout the year to accommodate the changing business environment. Hopefully, the thoughtful process that created the original budget will continue to provide needed structure and format to re-evaluate assumptions or assess new variables.
Assumptions - A Management Opportunity
Any forward-looking process requires assumptions to be made. This is frequently an uncomfortable part of any planning process because we’re dealing with unknowns. When approached logically, the fear is reduced and a plan emerges. First a list of the necessary assumptions (i.e. sales level, gross margin, inventory level, accounts receivable level, bad debts, interest rates, etc.) is developed. Then input from key associates on these assumptions is requested.
Formulating and gathering assumptions can be an excellent management tool. In the budgeting process, associates with functional responsibilities should be asked how they plan to improve their areas in the coming year. As an example, the inventory control department would be asked to project inventory levels and to describe anticipated actions to achieve those levels.
It is important for the management team to consider all known assumptions before the budget is compiled. Once assumptions are made and accepted by management, they must be documented. In turn, they become an integral part of the budget. To accept an annual budget and have true buy-in, the people charged with implementation must be comfortable with the assumptions behind the budget.
Annual Budgeting - Planning and Organizing
Annual budgeting can also be used as a planning and organizing tool for the company. Planning can range from very broad (strategic) to very narrow (operational or tactical). Our definition of planning is the ongoing process of developing the business’ objectives and determining how they will be accomplished.
Managers generally agree that thinking and gathering information always should precede planning, and planning always should precede doing. A group effort can be more efficient if everyone involved knows how, when, where and what will be done, and who is accountable for which parts.
Organizing is management’s way of aiding coordination by blending financial, human and physical resources. Done properly, organizing establishes the internal structure of the firm and turns planned steps into realities. In this stage of the process, tasks are assigned, deadlines set, and resources allocated. Any needed additional resources or structures are normally uncovered as the organizing process unfolds.
Annual Budgeting - Staffing and Leading (Delegating)
Annual budgeting presents a good opportunity to address proper staffing and to offer techniques for directing and leading associates, ultimately providing options for delegation and measurement.
Staffing is concerned with keeping qualified people in all positions necessary to accomplish the desired tasks of the business. Recruiting, hiring, training, evaluating and compensating are specific activities included in this function. Annual budgeting is an excellent time to address staffing needs and concerns for the coming year.
Once the right people are in place, the next management function is communication of goals and plans. An effective manager must be able to delegate tasks. This important function involves influencing people’s performance and behavior through methods such as motivation, communication, group dynamics, leadership and discipline. When properly done, personal career objectives will be met while the individual is helping achieve organizational goals.
Annual Budgeting - Control
The best laid plans……………..
The normal four-step process of implementing control is first to set the standard (or the budget); second, to record actual performance; third, to identify and understand variances from actual to budget; and finally, to take corrective or preventive action as necessary.
Management experts say compensation and reward systems always should be tied to the desired goals of the organization and the individuals involved. Only when both are in alignment will maximum performance be focused toward the desired outcome.
Counting What Counts
Some firms have supplemented traditional budgeting by including non-financial measures as part of the budgeting process.
It is important to understand the indicators of success in your business. These performance drivers enhance long-term value. As an example, if total quality was an indicator of success, defect levels and credits written might be measured as part of the budgeting process. If maintaining customers long-term is critical, shouldn’t on-time delivery, customer satisfaction, and adherence to customer needs be measured?
Operations people armed with relevant measures and understandable results can advance companies significantly toward agreed upon goals.
In the January-February 1992 Harvard Business Review article, “The Balanced Scorecard - Measures that Drives Performance,” Robert Kaplan and David Norton introduced a methodology that is becoming used widely. In this article they create a balanced scorecard that links four performance measures: customer perspective, financial perspective, innovation and learning perspective and internal business perspective. Kaplan and Norton say managers need a balanced presentation of financial and operational measures.
Marc Epstein and Bill Birchard take many of these ideas further in their 1999 book, “Counting what Counts.” Epstein and Birchard indicate that measuring performance drivers will help create an accountable organization. They see many benefits from building an accountable organization including:
Financial measures tend to be a lagging indicator of a firm’s performance; while properly used operational measures, normally are considered to be a leading indicator. Non-financial measures can be a powerful tool to help managers clarify and communicate strategy.
Subsequent articles will examine each aspect of budgeting as a management tool in greater depth.
Article published in the The MHEDA Journal Online Summer 2002 Issue
Robert Loeb is the President of Robert Loeb and Company LLC, a professional consulting organization focused on increasing the client’s shareholder value. The firm also specializes in identifying, documenting and implementing “best practices” within businesses in the contracting and distribution industries, as well as assisting in acquisitions and divestitures. Contact Robert at (361) 485-2223; fax (361) 575-5560, or e-mail firstname.lastname@example.org or visit his Website at http://www.robertloebandcompany.com/
Michael E. Workman, Ph.D., is an accomplished author, speaker and instructor of management, leadership and business development programs. Dr. Workman is Professor Emeritus of the Industrial Distribution facility at Texas A&M University in College Station, where he taught for 19 years. He does presentations and consulting work globally for distributors and manufacturers in marketing, sales, purchasing, sales management negotiation and operations management. Contact Mike at (979) 694-1825, fax (979) 693-9710, e-mail email@example.com or visit his Website at http://www.mworkman.com/
© 2002 Media Magic