Beyond Budgeting

A note for our readers: the views reflected by the authors do not reflect the views of ASPA.

By Scott Lazenby

Previous columns have focused on “Theory Y” budgeting as a long-overdue, budget management reform in government organizations. Allowing departments to carry-over 100 percent of budget savings, setting budget targets rather than using a budget “request” process and holding departments accountable for the bottom line rather than individual line items are all important elements in aligning the budget process with principles of good management. But do these reforms go far enough?

There is a small but growing movement in the private sector, beginning with some European companies and spreading to some US ones as well, that questions the very notion of a budget. Circumstances change so quickly in the current Information Age, the argument goes that being locked into the traditional annual budget plan can harm rather than help an organization respond appropriately to fast-moving challenges and opportunities.

The alternative is not merely to stop budgeting, but to replace a fixed budget cycle with the following kinds of elements:

• A rolling forecast (e.g., on a five-year horizon) updated fairly frequently (e.g., quarterly) that puts the organization’s current financial picture in context with a longer view of financial and market trends. This also allows the organization to test the effect of current decisions on the long-term health of the organization, under varying assumptions about the future.
• Key performance indicators—for example, return-on-capital, net cash flow, cost-to-income ratio—rather than fixed spending amounts and an emphasis on outcomes that further the organization’s goals.
• Allocation of the firm’s (central) resources through fast-track approvals of seed money or investments in new ventures on an as-needed basis rather than according to some fixed and arbitrary calendar date.
• Accurate snapshots of the financial health of the organization provided in real time via modern computer-based finance systems, no matter how large and far-flung the organization. The focus is on trends and forecasts rather than looking through the rear view mirror.

While these elements are a response to the shortcomings of traditional budgeting by corporations, governments share some frustration with the budget process. No matter how we dress it up, few citizens actually show up for budget hearings. This is because the vast majority of the budget is simply the result of a series of policy decisions that have already been made. Employee pension rates are set by an actuarial analysis based on past benefit promises and employee pay scales. Health benefits are set by union contracts. A decision to build a new fire station, school or swimming pool locks the government into inescapable operating costs. Long-term agreements set the wholesale cost of water. Lease-purchase agreements set the cost of street sweepers and fire pumpers. Federal and state mandates affect the costs of social services and sewage permit fees.

In rare cases, these decisions are made concurrently with the annual budget; usually they are not. Sometimes the long-term consequences on the operating budget of major capital improvements are explicitly addressed when the capital decisions are made. All too often, they are not, in spite of a century of doing annual budgets.

Against this reality, the concepts underlying the “beyond budgeting” movement make some sense. The operating costs of a building or other public facility shouldn’t be ignored until some future annual budget process comes around (when the facility comes online). Instead, they should be fed into the rolling forecast to make sure they will be sustainable. Self-supporting operations make up an increasing share of state and local expenditures in our current tax-adverse environment (and one in which taxes, when they are approved, are increasingly limited to very specific services). The bottom-line approach here is clearly a useful one: the direction from the governing board and CEO to the operating managers is “squeeze the most service possible from your available revenue, and otherwise don’t bother us.” Decisions on the use of general revenues or cash balances as a grant match must be made when the grant opportunity comes up. Budgeting for competitive grants in an annual process is always a (pointless) crapshoot. And real-time financial indicators should prompt an immediate reaction when it appears the organization is heading for a financial cliff; waiting until the beginning of the next budget cycle only compounds the problem.

Legal Limitations

An objection to a “beyond budgeting” approach could be a legal requirement to have an adopted annual (or biennial) budget. This is a very simple problem to solve, in this way:

1) Estimate revenues for the fiscal year based on past trends, and then double or triple the estimates.

2) Set budget appropriations at the highest organizational level legally possible (e.g., total appropriation for a department), balanced to the (inflated) revenue estimates.

3) Stick the budget in a file somewhere, and forget about it. If the revenue estimates (and corresponding appropriations) are set high enough, actual spending is guaranteed to come in under budget. This is all that matters.

Note that this approach is appropriate only if it is used as an exercise to meet arbitrary and outdated requirements of state law, where the real financial management is done in a different (better way).

Conclusion

A discussion of public budgeting is usually confined to one of two contexts: a political process that attempts to tie policy decisions to the allocation of financial resources or an accounting process in which appropriation amounts are simply data points in a system with a lot of numbers in it. It is rare to consider the internal budget rules and processes as an expression of a management philosophy. The “beyond budgeting,” movement, as with the Theory Y approach described in these columns, explicitly recognizes the importance of designing a process for managing financial resources that complements, rather than undermines, the things we have learned over the past half century about motivation and human relations. Consider the introductory statement of the Beyond Budgeting Round Table:

When the Beyond Budgeting Round Table (BBRT) was established over 10 years ago its vision was to find steering mechanisms that could replace budgeting and help to make organizations more adaptive to change. But its members quickly realized that management processes (the way we set goals, strategy, plans and budgets, allocate resources, coordinate actions and measure, reward and control performance) with budgeting at their core were not neutral in terms of management thinking and behavior. In fact, these processes were designed to enable leaders to command and control the actions of front-line people. Head office did not want managers to think or act on their own. In fact, they didn’t want any surprises. So if leaders now wanted managers to be more responsive, innovative and ethical, what did they need to change? The answer was not about fixing a few problems. It required a new way of thinking about management. It meant designing a new coherent management model.

…The management model (how you set targets, recognize and reward people, plan actions, allocate resources and measure and control performance) is the primary driver of management thinking and behavior in organizations today and has a major influence on the bottom line. It is also the key to survival in turbulent times. And while recent times have been the most turbulent in living memory most companies continue to manage with performance management models that are annual, negotiated and fixed and that add too little value.

This statement refers to private companies, but the comments could apply to governments just as well. At the beginning of the 21st century, both the private and public sectors need to find better ways to budget, or not to budget at all.

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