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How to Get Real Value out of the Budgeting Process
On April 27, 2016 / By William Aimone

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Pundits argue budgeting is a useless exercise and companies should curtail the efforts. In many organizations, budgeting becomes mere drudgery to appease the executive team. The budget process is long, and once complete, rarely reflects what management believes to be true. For example, a cost center budget is typically developed based upon historical costs with some small percentage increase or decrease. The process does not add value.

Convincing an entire executive team to eliminate budgeting is close to impossible. However, there is a way to get value out of the budgeting process.

Think about the last time you hired a service provider to do anything. There was likely a signed agreement containing expectations of both parties with an agreed upon set of fees in exchange for the work.

Why not use the budgeting process to allow each of the service providers in the organization (Finance, Human Resources, Engineering, Marketing, etc.) to “contract” for the work? For example, the Cost Accounting Department’s primary goal is to accurately capture product and inventory costs to enable make/buy, capacity and pricing decisions. The cost accountant’s customers include marketing and plant managers. The cost accounting team’s budget would be considered the price marketing and plant managers pay for the cost accounting services. This price (or cost) can be weighed against the value provided.

The budgeting process should allow each of the business functions to revisit what they do in terms of value provided to the organization. Functions can be stacked against each other in terms of the value provided and used as a means to reduce costs or build high-value capabilities.

Organizations have adopted the concept of service level charters as a means to drive value out of the budgeting process.

For example, a CFO has a global $6M budget for cost accounting whose value is considered high and a $7M global budget for accounts payable staff providing considerably less value. The immediate argument is accounts payable requires more effort. However, why would an organization spend more on activities that result in lower value? The CFO creates service level charters for Accounts Payable, Cost Accounting and the other finance functions. The service level charter outlines the scope of work, services provided and associated costs. The service level charters expose the inefficiencies with accounts payable and an effort to streamline processes allows the accounts payable budget to be cut in half.

The concept of a service level charter contains 5 key components:

1. Real Value

Each charter must have some connection with what is strategically important to the company. It is easy for the engineering department to identify the value of new product development. However, it is more of a challenge for the internal controls group to define their value statement. That being said, the Internal Controls Department keeps the executives out of jail. How is that for value?

2. Transparency

Department managers often shy away from sharing budgets with peers for fear of finger pointing. However, sharing the cost of the business functions should be transparent across the organization. A department manager who cannot justify his value should be challenged. There is nothing wrong with peer pressure to reduce costs and demonstrate value.

3. Service Expectations

In any contract, it is important to set service delivery expectations. It is easy for the cost accountants in the plants to get dragged off performing special assignments for the plant managers which have nothing to do with controlling and analyzing plant costs. Nonetheless, these special assignments are of value for the plant managers. The cost accountant’s delivery expectations for performing the special assignments need to be in the service level charter and budgeted accordingly.

4. Customer Expectations

As with every service agreement, there are expectations from the customer. In a service level charter between a technical support group and plant operations, plant operations would expect timely reporting of support issues. The old adage “I cannot help you if you don’t help me” applies here.

5. Measurement of what Matters

Defining performance metrics tied to the budgets is important. For example, a safety organization’s key measure is lost time incidents. During the budgeting process, some may believe there are too many safety supervisors. At the same time, the organization has zero lost time incidents displayed on the service level charter. The metric curtails any debate over costs.

Developing service level charters should be a simple process. Organizations may try to over-engineer the process.

Keep the service level charter simple:

1. Stick to One Page. The charter should be simple enough to put on one page in a 12+ font. Anything longer and the customer will not take the time to read.

2. Select Few Measures. Do not try to develop too many measures or select complicated measures. The easier to calculate the measures, the more likely everyone will understand.

3. Keep it High Level. This not about creating bureaucracy and trying define the specifics of every business function.

4. Stay Flexible. Organizations need to stay fluid and understand business changes may mean straying a bit off course to address the unexpected.

Implementing service level charters in an organization might be disruptive, but in a good way. Service level charters can drive a change in the culture of a complacent organization stuck in the process of budgeting for the sake of budgeting. Budgeting is not fun. But it can be if it is competitive and value focused. Trenegy has developed a service level charter format used by leading organizations. For an example, please contact us at info@trenegy.com.