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ALTERNATIVE BUDGETING
There are, however, a couple of disadvantages to zero-based budgeting as well.
The most obvious one is that it is very time-consuming, as it is a completely bottom- up approach, which is redesigned annually. Hence, employees will need much more time to complete their annual budgets. Second, although budgeting depends on many assumptions, typically companies use the previous year’s assumptions as a basis. In this approach, each assumption has to be determined without looking at the previous year’s budget. If the assumptions are incorrect, then the budget will not be accurate and will be of little help to the organization. In sum, this process can be useful if the organization has the time and knowledge to make accurate assumptions.
ACTIVITY-BASED BUDGETING
Activity-based budgeting is an outgrowth of activity-based costing, which character- izes the “true” cost of providing a product or service (internal to the company or ex- ternal to the customer) by obtaining and analyzing how workers spend their time.
Activity-based costing is often thought of as a thorough approach to allocating costs that can be used to refine pricing models and improve profitability analysis.
In simple terms, activity-based budgeting is focused on the processes within the organization that are pertinent to the success of company. Therefore, instead of bud- geting for the sales department, a manager will budget for the process of securing a new sale. The manager will determine the costs associated with the sale process, rather than determining the costs of the entire department.
The success of this approach is based on the effectiveness of implementation.
The positive aspects of this approach, if implemented well, are that:
• You will end up with a detailed understanding of the organization’s costs.
• The company will have increased control over its expenses.
• There will be an improved understanding of the company’s activities and how they are linked to the costs of those activities.
• The internal discussion of all cost drivers will improve, which will enable all employees to understand the drivers.
If not implemented successfully, the negatives aspects of activity-based budget- ing are as follows:
• Results may be ignored and allocated costs can be debated since the allocation methods will be very difficult to determine when using this method.
• The approach is difficult to implement and requires the company to use an activity-based costing system.
• Workers must record how they spend all of their time, a time-consuming effort, and one that employees may resist.
• The system is all based on how employees track their time; therefore, your com- pany must be aware of “garbage in, garbage out.”
BALANCED SCORECARD
A Balanced Scorecard is a method for linking the strategies of different departments within an organization, such as marketing and manufacturing, to the overall corpo- rate strategy. David Norton and Robert Kaplan, a Harvard Business School professor, found that the standard financial measures the majority of companies were utilizing did not provide enough information to effectively manage their companies. Kaplan and Norton recommended that managers concentrate on the financial and nonfinan- cial metrics that truly specify how well their companies were performing.
In essence, the Balanced Scorecard approach directs decision makers to concen- trate on only the information that is pertinent to making the best decisions. Simply, the managers will view less but more relevant data; therefore, the data will be more readily available and more succinct, meaning that more time can be spent evaluating, rather than accumulating, the data.
The main drawback to this approach is determining what to measure. Manage- ment must have clear goals so that quantifiable measures can be developed to analyze the strategy. The measures chosen should cover all functional areas of an organiza- tion, such as customer service satisfaction, inventory turnover, quality assurances, and return on assets. Subsequently, these measurements must be communicated to the en- tire organization and everyone should be focused on improving these measurements.
In order to use this method effectively, the data must be accessible to all individuals approved by the organization to view improvements.
When using the Balanced Scorecard approach to budgeting, the process is less complex because it focuses only on the measures that the management has chosen.
This approach also links the organization goals and strategy more closely with bud- get than any other budgeting process. Typically, companies have well over 200 bud- get line items, but this approach recommends that you budget on fewer than 40.
This approach follows the 80/20 rule, which means that 20 percent of the items in a typical budget drive 80 percent of the business.
This approach also confers some very important improvements on the budget- ing process. The first is the significant time savings earned because fewer items are budgeted. And fewer measures also mean employees can be reviewed more effec- tively on their performance; and the employees will better understand how they are being evaluated. Employees will be more effective, too, because they can focus on the main areas in the company and not be overwhelmed by an immense process and then feel they are judged unfairly.
Like all budget processes the Balanced Scorecard also has limitations. For one, it is very difficult to find the key measures that drive approximately 80 percent of the organization, so many managers will throw in too many measures. Consequently, the Balanced Scorecard slowly becomes a typical budget as more and more measures are selected. The problem occurs primarily when the wrong measures are identified, causing the company to concentrate on areas that will have little effect on the com- pany, while ignoring the more important ones. (Many managers will also ignore the nonfinancial measures, but this is one of the main benefits of the Balanced Scorecard.)
BEYOND BUDGETING ROUND TABLE
Consortium for Advanced Manufacturing International (CAM-I), an international not-for-profit collaborative research consortium founded in 1972, concentrates on management and technical issues of common interest to a number of organizations that combine their resources to find realistic solutions to budgeting problems. The Beyond Budgeting Round Table (BBRT), one of CAM-I’s major international pro- grams, was formed in 1998 to explore why some companies had discarded the bud- geting process. (Some of the companies that have sponsored the BBRT since 1998 include Ernst & Young, Anheuser-Busch, and KPMG Consulting.) Specifically, the round table participants sought to understand the alternative instruments these com- panies had adopted and whether these adjustments were associated with the advance- ment of a new financial model that is more in tune with today’s business environment.
The round table members believe that using traditional budgeting is a serious handicap in today’s evolving and tumultuous markets. They would like to see com- panies move from forecasting to real-time responsiveness and from centralized deci- sion making to empowerment. Also, they feel that companies must respond quickly to customer needs, become flexible to change, and adopt a set of performance man- agement procedures better aligned with organizational objectives. The key strategy isknowledge, rather than financial capital.
Today, most companies are trying to improve performance management. Some have decentralized decision making or dismantled their hierarchies, while others use different mechanisms such as the Balanced Scorecard method just described. The
“Beyond Budgeting” model may include some of these different methods, but it also provides a structure for linking them together and then prioritizing future plans.
Thereafter, the business will be managed in two ways: devolutionandmanagement.
Simply defined, devolution means giving the departments the autonomy to make decisions, to enable them to respond in a more timely manner, and to determine their strategy, and to manage their resources. The goals of devolution are to create as many departments as possible for maximum benefit and to encourage the departments to simulate market conditions when dealing with each other.
Of course, company managers will need to communicate the goals and the lim- itations of each department. Also, they will be responsible for determining the results and evaluating the departments on their success. Management will also have to pro- mote constant improvement and collaboration.
This new focus on the budgeting process is still in development. To date, only a few companies are using this method; it is not yet a standard.
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