22 – Alternatives To Budget Cuts

Budget Alternatives

With budget season upon us again, how do we make this process more rewarding and less painful.

Elaine JonesAlternatives to Budget Cuts

Elaine Jones reveals how target cost eliminates across the board budget cuts.

John MillerOverly Optimistic Budgets

John Miller responds to a viewer’s frustration with his company’s overly optimistic budgets and the annual pain of missing an unattainable budget.

Click HERE to enter your own question.

In episode 23

Budget Alternatives

Coming up on Performance Management Edge… Alternatives to Budget Cuts and Overly Optimistic Budgets.

Budget Preparation Season, these words bring chills to many in management. Few outside of the budget department seem to appreciate the process. But they seem to provide a structure that few are willing to part with. Yet, how could we manage budgets better. Today, we’ll see two different aspects to managing with budgets.

First, Elaine Jones will present an alternative to across the board budget cuts using target cost. Later, a viewer questions his management’s habit of wearing rose colored glasses when preparing their budget. John Miller has an answer for him.

First, Elaine, over to you.

Elaine JonesAlternatives to Budget Cuts

Today’s economy is a challenging environment. Tight margins and global competition drive shrinking budgets and in many cases budget cuts. We have all experienced in one way or another a budget cut. Budget cuts are a challenge to implement. There never seems to be a good way to absorb the cuts. In many cases, budget cuts are applied across the organization and everyone suffers. Wouldn’t it be better to apply budget cuts in a manner that focuses on the customer? That retains the key attributes of the products and services that customers value and only reduces or eliminates lower priority attributes based on the customer’s assessment.

Target Costing offers an alternative to the pro rata cut approach to budget reductions. The target costing methodology begins by identifying the total desired end result, mapped to the processes based on a prioritization and weighting of customer needs. The end result is a budget that reflects, proportionally, what the customers see as important.

Let’s walk through an example of what I am describing. Let’s look at a product development organization with a budget cut of 20%. This level of cut is too big to just watch spending and cut back a little here and there. Something will have to be cut from the project list. Rather than reducing all projects by 20% which would impact all products, the projects should be prioritized based on customer needs and the project that is slated to deliver the lowest priority features should be canceled or delayed to a future budget year.

Now let’s look at another example. In this case, it is a service based business like a lawn care company. The competition has been increasing in the area and the company realizes that to stay in business they must reduce operational spending by 20%. The easy approach would be to reduce the number of employees and get by with less manpower. This approach can quickly jeopardize the satisfaction of the customer when service quality and/or timeliness is impacted. Instead, the management should understand customer prioritization of lawn care. Of the services that are included in the lawn care experience, cutting, edging and clean up are highly desired by customers. But, collecting and bagging the lawn clippings are of low importance to the customer. Bagging the clippings cost extra in terms of manpower and the bags to collect and dispose of the clippings. So, eliminating this service is okay with customers and reduces expenses without jeopardizing the quality of the service experience with the customer.

Target Costing methodology focus on the customer, providing what they most desire and managing cost to produce or deliver so that a reasonable profit is made. Both sides can win in this approach. And there can be wins on both sides for budget cuts as well.

Thank you Elaine. To me, across the board budget cuts have always seemed to demonstrate management’s lack of understanding of their own business. Thank you for an alternative.

Let us hear your opinions. Elaine and I would love to hear your experience and comments on managing with budgets and especially on effective use of target cost. What has worked for you? Scroll down the page at Performance Management Edge dot com and let us hear your opinion.

Now for today’s question submitted by Darren.

What tool / approach do you recommend to mitigate the unrealistic & ever optimistic approach often demanded by upper management when making a budget? Our co has seen major, unforeseen, unexpected “bad news” resulting in million dollar costs year after year, but no “bad news” is ever included in the budget! They push for activity which is above average (past yr, past 5 yrs) & then never expect anything bad to happen! And then are disappointed / upset when we miss budget numbers!

Here’s John Miller with an answer for Darren.

John MillerOverly Optimistic Budgets

For an unrealistic and ever optimistic approach to planning and budgeting, especially when it fails year after year over a long period of time, I recommend a baseball bat. Whack, one tap to the side of the head to introduce reality.

Your company has seen “major, unforeseen, unexpected ‘bad news’ resulting in million dollar costs year after year, but no “bad news” is ever included in the budget!

Better than a baseball bat, here’s a call to action–

First determine why the company keeps getting unexpected bad news.

Is it because of lost customers, product failures, sales declines, price reductions, quality issues, breakdowns, increases in material costs, market trends, environmental costs and fines, or simply actions taking by competitors?

Answering these questions is the starting point for understanding the reasons for unexpected bad news. What why how when and where are the questions to ask. Dig for answers. Is there a pattern or similar events? Is this something you should have expected? Had you known it was coming, could you have prevented it? Was it beyond your ability and control to expect or stop these events?

The next action you could take depends on the result of the first step. Once you understand the what, why, how, when, and where of bad news you are better positioned to plan for these events and include them in the budget. Problem solved.

If there is no way to predict what kind of bad news will hit you in the next budget cycle then a solution is to include a contingency amount in the budget, a kind of reserve that can absorb these kind of yearly surprises. This simple approach should solve the problem and make your budgets more realistic.

But, if you really want to improve you’re planning and budgeting capability, join the community of companies that are rethinking and improving their entire planning and budgeting process.

First are rolling forecasts and budgets. The world moves fast and changes happen quickly in the competitive world we all live in. With rolling forecasts and budgets, the process is about continuous planning and budgeting rather than a once a year budget event. Companies that embrace rolling forecasts and budgets continuously look out 4-6 quarters. At the end of a quarter they add a quarter to the plan and budget. Compare this approach to the once a year “cast in Stone budget event” which for many companies is a six to nine month process with the resulting budget often obsolete before the start of the plan year.

Driver-Based Planning is another way companies are improving their budget and planning capability. Drivers are factors that have a causal relationship to plans and budgets.

  • The expected number of widgets to be sold drives the resources (amount of work required) to make the widgets expected to be sold.
  • Commodity prices are drivers of raw material costs. Gasoline prices are a driver of transportation costs.
  • For a mobile telephone company like Sprint, the number of phone lines is a driver to most of the operations, including bandwidth requirements, consumer support, and IT costs.
  • Drivers also include external data to predict and plan the future. For an Oil and Gas company, external data would include the price of crude oil, number of drilling permits issued, average daily production from specific types of formations, and the availability of rigs and crews.
  • External data could also be long term weather forecasts (a drought for example), expectations about the economy, or even unstructured data from the social media.
  • The number of people tweeting back and forth about how much they like your new product is a driver of future product sales!

Until next time, thanks for listening in.

Thank you John for your response to Darren. Thank you Darren for your question.

Now to our viewers. Do you agree, or Not? I’m sure everyone has some sort of feelings about their budget. How can you apply what you have heard in this episode? Whatever it is, let’s hear your viewpoint. Please share your view below this video at Performance Management Edge dot com.

In addition to comments, we also appreciate your questions like this one. With your questions, we customize this show to your own issues. Ask your question on the “Ask Us” tab at Performance Management Edge Dot Com or as a video on our YouTube channel.

In appreciation for his question, we’ll arrange a time for Darren to have a 30 minute telephone or Skype discussion on topics of his choice with one of our experts. And, we’ll send him a copy of “Implementing Beyond Budgeting – Unlocking the Performance Potential” by Bjarte Bogsnes.

Thank you to the Beyond Budgeting Round Table for furnishing this book.

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Remember: Business Management is more of an art than a science. Don’t wait for tomorrow to get started. Start today making these perspectives part of your business art.

On behalf our viewers, I thank our experts. Join with us on the next episode for more business insights.

And remember, Performance Pays Profits.

One Response to “22 – Alternatives To Budget Cuts”

  1. Steve Player says:

    Rather than trying to make a bad budgeting process better, organizations are much better served by moving completly Beyond Budgeting. See the recent CFO magazine cover stories from May 2011 “Let It Roll: Why Companies are Abandoning Budgeting in Favor of Rolling Forecasts” and Sept. 2012 “Freed from Budgets.” You will learn how to leapfrog to greater performance.