More innovative, strategy-linked planning and budgeting is the future, says Cranfield School of Management. By Tim Cooper, editor e-mail newsletters and Stathis Gould, head of technical issues, CIMA.
Businesses need to use planning and budgeting processes in better and more innovative ways to maintain a long-term competitive advantage. That was one of the conclusions of a speech given by Dr Mike Bourne, director of the Centre for Business Performance at the Cranfield School of Management, at a conference hosted by software company ALG and the Institute of Chartered Accountants in England and Wales (ICAEW).
Bourne began his speech by summarising criticisms of planning and budgeting thrown up in previous research. Many companies find that budgets are time-consuming and costly to put together. They constrain responsiveness and flexibility and are often a barrier to change. They add little value especially given the time required to prepare them. They focus on cost reduction rather than value creation and they strengthen vertical command and control. The biggest criticism, however, is that budgets are rarely strategically focused and are often contradictory.
Budgets do not reflect the emerging network structures that organisations are adopting. They can encourage "gaming" (managers playing politics to secure a bigger budget) and perverse behaviours. They are based on unsupported assumptions and guesswork and are developed and updated too infrequently, usually annually. Budgets reinforce departmental barriers rather than encourage knowledge sharing. They can also make people feel undervalued.
So much for the bad news. But a link between effective planning and budgeting and shareholder value is shown by performance improvements in three areas:
improved management underpinned by better forecasting, strategy formulation and execution;
better management of market expectations through improved communications based on better management information; and
better company performance underpinned by actual financial performance, performance against expectations and expected future performance.
Bourne presented the results of research by Cranfield into 15 companies that use enhanced budgeting and planning practices. He said none of the companies - which included Cisco Systems, ABB, BP, Skandia and Volvo - took a standard route but picked their own approach to fit their circumstances. Their aims include trying to forecast more accurately, more efficient planning and budgeting, and better executed strategies. A few are also trying to establish real connections between financial performance and value drivers: this is why better budgeting is often inextricably linked to the use of the balanced scorecard.
There are now tools available that can cover a lot more than just budgeting - for example, being more forward-looking with rolling forecasts over longer periods. Traditional budgets that give employees financial targets and measurements can be re-engineered with the balanced scorecard approach, with non-financial targets and measurements linked to strategy and relative targets linked to the market rather than to performance against budget.
Traditional budgets gave us limited cost understanding but now we can control costs better with activity-based accounting and product costing. They also gave us a sterile and fixed annual plan but now we can foster flexibility with a longer-term outlook, trend reporting and more decentralised decision making, and we can ensure that there is a focus on shareholder value by having a value-based investment management approach.
Bourne said that the 15 organisations studied are adopting and evolving new processes for planning and budgeting. No single company seems to encompass one framework; they are all simply applying solutions to their own individual problems. None of the companies in the study has adopted all 12 principles of the beyond budgeting management model developed and advocated by discussion group the Beyond Budgeting Round Table. But there are common threads that enabled the researchers to construct a list of insights into best practices.
Faster forecasts
Rolling budgets and forecasts play an important role in the performance management process of leading companies. When deployed with appropriate enterprise-wide technology, forecasts can be consolidated quickly, enabling estimates of performance five quarters or more in advance, as well as of major capital expenditure programmes. The use of historic data over, say, two years and an outlook for five quarters shows trends for high-level key performance indicators (KPIs).
This approach enables an organisation to be more responsive to changing circumstances. Some people argue that a rolling budget can in fact consume more time and cost but the level of detail at which it is set and the modelling finesse behind the forecasting is important. Forecasting should be based on the business model, its drivers of value and key trends and priorities. There should be discussions around the assumptions on the drivers of income and expenditure. The more assumptions there are, the more complex the process can become.
Finally, it is only by forecasting regularly that the process can act as a control and also be motivational and inspirational.
Leaner reporting and review
According to Bourne, leading companies are reducing the cost of their financial planning and reporting by judicious investment in IT to create integrated and widely accessible cost and revenue databases. These are designed to create a single version of the truth on company performance and they reduce duplication of effort in running separate legacy systems. Leaders are also light on their review process, focusing on a few key performance measures rather than reviewing every line item.
Strategically, not financially, managed
Leading companies understand that better financial performance comes from developing and executing good competitive strategies. It does not come directly from better financial management. They plan and manage investments separately from the day-to-day operations of the business. They focus more on the achievement of non-financial drivers of performance than on monthly financial results and so frequently use tools such as strategy mapping or value mapping to understand the business model and its levers.
Leading companies also understand the concept of the action/performance lag - in other words, the time between the start of an intervention and the resulting improvements in performance. This prevents the continual initiation of projects that are supposed to create short-term benefits but inflict long-term damage by consuming management time and resources then being taken over by other events before completion.
Competition, not budget, focused
Bourne said that leading companies are externally focused. Comparisons are made not with budgets but with the competition. Targets are not based on current performance but on external benchmarks. Incentives are disconnected from budget achievement and instead focus on beating the competition, both financially and non-financially.
Innovative reward systems characterise those companies that have been most radical in this area. For example, Svenksa Handelsbanken, the leading Swedish bank and proponent of "beyond budgeting", bases its bonuses on beating the competition. These are calculated by the amount that the company is outperforming other banks in the Scandinavian banking sector. This is not paid as salary but included in employees' pension pots.
Setting appropriate bonus schemes can be complicated in global organisations by the different sub-cultures in different regions. In China, for example, it can be difficult not to relate bonuses to the budget.
Actions, not explanations
Leading companies are far more concerned with managing future results than with explaining past performance. This involves:
forward planning and good forecasting - variances can be explained before they occur;
managing using the forecast rather than the actual results;
focusing on the actions that drive performance and shareholder value maximisation, most of which are non-financial.
The key factor in being action-oriented is trust. Working on management's forecast with disregard for the actual results requires trust because head office will be using forecast information to predict year-end results. To encourage this kind of culture companies such as BP have stopped using the term budgeting.
Bourne said that there is one fundamental difference between traditional planning and budgeting and the approach taken by forward-thinking companies. Under budgeting, control is exercised by business units and divisions reporting their actual performance and variances. This leaves the head office to use this information to predict the year end results. Forward-thinking companies trust their managers to tell them what they will achieve. You cannot work on management's year end forecasts, with almost total disregard for the actual monthly results, without trust.
So can we all go "beyond budgeting"? Bourne said that the ability to eliminate a traditional approach to budgets requires certain criteria. These include:
an appropriate performance measurement and management framework. Many companies find the balanced scorecard a key tool in managing performance because of its integration to strategy and the ability to set relevant performance measures;
continuous updates and revision of assumptions inherent in the business model. To ensure forecasts are not based on opinion, an organisation needs to understand its revenue streams from customers and costs incurred by product and market;
sophisticated external market research;
regular use of external benchmarking information;
clear, rapid and reliable performance measurement reporting systems based on IT systems that help rather than hinder data collation and analysis.
A major communication and education drive is also required.
Finally Bourne offered some thoughts for the future. He said businesses need to use planning and budgeting processes as a strategic tool in order to base a competitive advantage on being strategically rather than financially managed. Financial plans and budgets need to be aligned to strategies, while effective strategic performance measurement and management processes must be introduced or enhanced. This includes implementing appropriate reward systems so that the link between a budget figure and salary is broken.
Many companies have not changed their budgeting systems for years. There is no single solution that will fit every company's needs but making some of the changes discussed may help you make advances in your planning and budgeting process.
Cranfield School of Management will hold a CIMA-sponsored conference on 28 January, New departures in planning and budgeting, at which Mike Bourne and some of the 15 companies studied will talk about how they have departed from a more traditional approach to planning and budgeting. Visit the Cranfield School of Management website.
