The Ultimate Lean Budget
If you are willing to modify the reporting system, decision making, and organizational structure of a business, it is entirely possible to not only operate without a budget, but to thrive while doing so. Thus, the ultimate lean budget is to have no budget at all.
Operating without a Budget
In order to have a properly functioning organization that operates without a budget, it is necessary to make alterations in four areas. They are:
- Forecast. The forecast is a rolling forecast that is updated at frequent intervals, and especially when there is a significant event that changes the competitive environment of the business. The forecast is simply the expected outcome of the business in the near term, and is intended to be an early warning indicator of both threats and opportunities. It is completely detached from any compensation plans.
- Capital budgeting. Requests for funds to buy fixed assets are accepted at all times of the year. Funding allocations are based on expected results and the needs of the requesting business unit. There is no formal once-a-year capital budgeting review.
- Goal setting. Employees jointly set targets that are relative to the performance of other business units within the company, and against other benchmark organizations. If there is a bonus plan, it is based on these relative results.
- Compensation. Bonuses and other compensation are based on the ability of the company as a whole to improve its performance relative to its competition or some other relevant performance baseline.
A key point is that the forecast and capital budget are not related to targets. By separating these processes from any corporate targets, there is no incentive for employees to fudge their forecasts or fixed asset funding applications in order to earn bonuses.
From the management perspective, it is critical that senior managers step away from the traditional budget based command-and-control system and replace it with a great deal of local autonomy. This means that local managers can make their own decisions as long as they stay within general guidelines imposed by senior management. The focus of the organization changes from short-term budgets to medium-term to long-term financial results. There is no emphasis on budget variances, since there is no budget.
Also, senior management must trust its employees to spend money wisely. The expectation is that an employee is more likely to question the need for any expenditure, instead of automatically spending all funds granted under a budget allocation.
From a more general perspective, if a company abandons budgeting, how does it maintain any sort of direction? The answer depends upon the structure of the business and the environment within which it operates. Here are several examples of how to maintain a sense of direction:
- Margin focus. If a business has a relatively consistent market share, but its product mix fluctuates over time, it may be easier to focus the attention of managers on the margins generated by the business, rather than on how they achieve those margins. This eliminates the structural rigidity of a budget, instead allowing managers to obtain revenues and incur expenses as they see fit, as long as they earn the net profit margin mandated by senior management.
- Key value drivers. If senior management believes that the company will succeed if it closely adheres to specific value drivers, then it should have the company focus its attention on those specific items, and not hold managers to overly-precise revenue or profit goals. For example, the key to success in an industry may be an overwhelming amount of customer support; if so, focus the entire company on maximizing that one competitive advantage.
- Few products and very competitive environment. If a business relies upon only a small number of products and is under constant competitive pressure, then decisions to change direction must be made quickly, and the organization must be capable of reorienting its direction in short order. This calls for a centralized management environment where a small team uses the latest information
to reach decisions and rapidly drive change through the organization. In this case, a budget is not only unnecessary, but would interfere with making rapid changes. Thus, keeping employees focused on the operational direction given by senior management is vastly more important than meeting revenue or expense targets; taken to an extreme, employees may never even see the financial results of their areas of responsibility, because the focus is on operations, not financial results.
This article is an extract from Steven Bragg's Lean Accounting Guidebook.
by Sue Anderson - Based on 30 years of experience in continuing education for accountants. Currently program director for online CPE provider, CPE Link. Formerly with the California CPA Education Foundation managing key operational areas including marketing, program development, and distance learning.