SECTION ASTRATEGIC PLANNING AND CONTROL

Appraisal of alternative approaches to budgeting for control

Focus notes:

-budgets are essential tools for turning strategy into action; are effective only if they support achievement of strategic objectives;

-contingency theory requires effective budget model to reflect requirements of strategic implementation within the relevant context; this can be assessed in relation to the following relevant criteria

-do financial plans reflect operational plans adequately and accurately in terms of resources, structures and operational requirements?

-do financial plans adequately and logically reflect the requirements of business strategy in terms of focusing on value creating activities and associated costs as required by Porter’s Value Chain Framework? Supporting competitive strategies: cost leadership and differentiation.

-budgets reflect the requirements of strategic management of market share: how do budgets allow for adjustments to sales, cost levels, prices to counter threats from competitors and build on strengths?

-must embrace and reflect Tocher’s control model: objectives, measures, input/output, alternatives.

-adequately address risk factors and the need to adjust plans to compete: scenario management; budgeting for competition

-strategically relevant performance indicators: e.g. market share targets, cost efficiency for cost leadership and management; financial position e.g. forecast balance sheet, cash flows.

-performance budgets are the outputs required: broad in scope, strategy focused, control enabling, competition enabling, performance enhancer; compatible with measurement and control frameworks such as the balanced score card

Evaluate the strengths and weaknesses of alternative budgeting models and compare such techniques as fixed and flexible rolling, activity based, zero-based and incremental. [3]
  1. The budget quantifies in financial terms all of the requirements for and consequences of translating strategy into action over the specified timeframe. Any suitable time frame can be chosen: one year, three to five years are common timeframes.
  1. Contingency theory states that there is no one budget model that suits all circumstances and purposes. Strategic financial planning should necessarily entail an exploration of alternative budgeting models to determine which model is most suited to the particular strategies and operational contexts envisaged. In this regard tradition is not sacrosanct: clear relevant criteria should be set to evaluate current models and to drive their modification and extension if they do not fit, or to design new ones. The relevance of the evaluation criteria should be judged in terms of how they support and enhance the prospects of successful strategy implementation and performance improvement. This will ensure that budgets are as fit as they can be by blending experience, ideas and discourse to achieve excellence in model design.

Dimensions(evaluative criteria) / Zero-based / Activity-Based / Investment-based / Incremental
Scope
Show how the model determines the scope of budgeting and the time-span / Budget for all operational units on the basis that they are starting afresh and continuity of service and production is not assumed unless properly justified. / Budget for all justifiable activities(justified in terms of what is required to fulfil the mission) / Budget for all products that meet relevant investment criteria.Aim for optimal funding: where internal rate of return equates to weighted average risk- adjusted discount rate. / Budget as if the past is a guide to the future – make adjustments to previous year’s budget only for authorised known changes.
Strategy focused
show how the features of the technique meet the requirements of strategy implementation
-conceptual compatibility
-clear focus on objectives
-performance drivers
-logical basis for resource allocation
-cost drivers / Conceptually compatible with design strategy lens as both products of logical process involving analytic and evaluative techniques. / Conceptually compatible with strategic requirements to evaluate all activities in terms of how they fit business strategy. A unique blend of design, experience, ideas and discourse produces a strategic fit of activities e.g. in NHS hospital service provision. / Design focus – product of strategic analysis and choice. Action is design centred. / Conceptually compatible with the experience lens of strategy formulation.
Justifying activities requires clarity and focus on objectives that are relevant to the strategy and may influence their setting / Analysing activities requires an assessment of value which necessarily requires a consideration of objectives. / SBUs plan the costs of their products and services in the light of acceptable risk set out in the business strategy / Clearly defined strategic objectives may not exist. In the context that permits incremental budgeting there is no logical necessity for a review of strategic objectives as continuity is assumed, based on past experience. Consequently, strategic priorities may be irrelevant.
Allocation of resources will be logical and focused on strategy implementation. / Allocation of resources to activities is compatible with strategic implementation requirements to resource adequately but not excessively. / Allocation of resources will be logical and focused on strategy implementation. / Basis of allocation is not questioned and may be inappropriate, illogical and inefficient.
Compatible with Value Chain Framework – analysis of value creating functions will identify cost drivers (e.g. volume of production) and value drivers (e.g. operations, investments, benchmarking, TQM, JIT,) / Perfect fit for Porter’s VCF. / Compatible with Value Chain Framework – analysis of value creating functions will identify cost drivers (e.g. volume of production) and value drivers (e.g. operations, investments, benchmarking, TQM, JIT,) / There is hardly any scope for VCF to be applied. Blunt weapon for business implementing business strategies.
Fits cost leadership and differentiationstrategies. Considers enterprise wide cost of strategy. Has potential to align all departments with enterprises strategies. / Fits cost leadership and differentiationstrategies.
Has potential to align all departments with enterprises strategies because activities, not departments, are budgeted. / Fits cost leadership and differentiation strategies. Considers enterprise wide cost of strategy. Aligns all departments with enterprises strategies. / No potential for strategic fit.
Departmental budgeting runs counter to integrated approach of strategic implementation.
Operational planning and performance budgeting
Explain how budget model ensures compatibility with strategic operational plans to achieve goal congruence and avoid conflict
-budgets must address requirements of approved operational plans
-budget setting requires collaboration with operational managers
-financial performance indicators compatible with operational performance indicators / The need to substantiate budgets under ZBB in terms of their strategic relevance logically requires matching of budgets to operational plans in a way that confirms that the right amount of resources are being deployed to meet strategic requirements. / The budget allocates resources to those activities deemed to be most appropriate for implementing business strategy through the chosen operational configurations. This assures effective and comprehensive budgeting for strategic priorities that reflect predetermined input/output model. / The need to substantiate budgets under IBB in terms of their strategic relevance logically requires matching of budgets to operational plans in a way that confirms that the right amount of resources are being deployed to meet strategic requirements. / As budgets are incremental operational plans tend not to be well defined as they are not required to justify expenditure or to set input/output relationships. This increases the likelihood that budgets may not reflect operational plans. This is a common cause of variances.
This engenders collaboration between cross functional SBU managers - fosters team spirit, co-operation, motivation, goal congruence and high performance. / Identifying value-creating activities requires collaboration with managers across the entire value chain to exploit the benefits of Porter’s Value Chain Framework. / This engenders collaboration between cross functional SBU managers - fosters team spirit, co-operation, motivation, goal congruence and high performance. / Collaboration is fostered by negotiation over budget limits. Participation engenders ownership and control aimed at staying within limits.
Sound basis for setting mutually agreed and relevant KPI that reflect critical success factors and allow for performance to be measured against strategic goals. / ABB identifies the drivers of performance – KPIs are based on these. / IBB identifies the drivers of performance – KPIs are based on these. / IBB does not identify value drivers, nor cost drivers. KPIs tend to be broad and unfocused on performance criteria.
Compatible with m’ment and control frameworks
Explain how the budget model fits or lends itself to the requirements of m’ment and control frameworks such as the balanced scorecard
-breadth of scope encompassing range of common performance and measurement criteria
-analysis relevant to critical success factors e.g. VFM input/output
-organisation into SBUs / Analytical approach, broad scope and quest for efficient and justifiable business use of resources makes ZBB compatible with other value-enhancing and performance management frameworks such as TQM, Benchmarking, Balanced Scorecard and Porter’s Value Chain Framework. / Analytical approach, broad scope and quest for efficient and justifiable business use of resources makes ABB compatible with other value-enhancing and performance management frameworks such as TQM, Benchmarking, Balanced Scorecard and Porter’s Value Chain Framework. / Analytical approach, broad scope and quest for efficient and justifiable business use of resources makes IBB compatible with other value-enhancing and performance management frameworks such as TQM, Benchmarking, Balanced Scorecard and Porter’s Value Chain Framework. / Not compatible with quality, performance measurement and control frameworks such as TQM, VCF, BSC for reasons given elsewhere.
Identification, quantification and prioritization of improvement opportunities / Identification, quantification and prioritization of improvement opportunities / Identification, quantification and prioritization of improvement opportunities / No focus on improvement opportunities apart from direct cuts which are often blunt weapons.
Based on which activities drive the business / Based on which activities drive the business / Based on which activities create adequate value for the business / Based on departments, functions or cost centres not necessarily focused on performance drivers.
Addresses risk and uncertainty
Explain how the budget model addresses risk and uncertainty
-process identifies inherent risks
-clarifies types of risks and how they arise
-built-in evaluation and control measures
-what risks would you be most concerned with?
-what strategies would you put in place to minimise risks? / The analyses required to justify expenditure and income forecasts and associated activities to be carried out in a changing future business environment prompt what-if questions. / The analyses of activities to be carried out in a changing future business environment prompt what-if questions. / The analyses required to justify expenditure and income forecasts and associated activities to be carried out in a changing future business environment prompt what-if questions. / Since incremental budgeting assumes past activities will be replicated in future its ability to detect and minimise business and financial risks is somewhat limited. Resource allocation and anticipated income may reflect the business model, but this may be out of date without a rigorous analysis to align it with strategies required to deal with the future. What-if analyses may be carried out but without a proper relationship between input/output such an analysis would have limited use in managing risks.
This leads to identification and appraisal of risks which could lead to modifications and refinements of strategies and business models. / This leads to identification and appraisal of risks which could lead to modifications and refinements of strategies and business models. / This leads to identification and appraisal of risks which could lead to modifications and refinements of strategies and business models. / Risks may be identified but they may not be the risks that matter most in terms of their potential impact on strategic priorities. For example, possible shortfalls in staffing budgets may be identified as risks but they may not tell us much about risks to the business’ ability to create value.
Scenario analysis is a key component of this technique and it allows for risks and uncertainties to be managed by testing how performance and the budget are likely to be affected by different scenarios. / Scenario analysis is a key component of this technique and it allows for risks and uncertainties to be managed by testing how performance and therefore the budget are likely to be affected by different scenarios. / Scenario analysis is a key component of this technique and it allows for risks and uncertainties to be managed by testing how performance and therefore the budget are likely to be affected by different scenarios. / Scenario analysis is not a logical requirement of this budget practice because the past is already known and that is what is expected to occur again.
Fixed budgeting
-Assumes one level of output e.g. 1,000 cars over the planning period
-Cost budget is fixed at that level / -Does not allow the level of output attained to be matched to the level of cost that corresponds to that output level. The result is that variances could be misinterpreted. This could lead to dysfunctional decisions.
-For example, if 50% of the budgeted costs have been spent and only 30% of the expected output has been attained then financial monitoring reports based on fixed outputs levels would not be helpful in interpreting the variance as the costs would not be flexed (adjusted to the attained output) to allow meaningful comparison and interpretation of variances.
-This is one of the main reasons budgets are criticised as useless for performance management.
-This type of budgeting is likely to be seen in not-for profit organisations where the costs are not built from the bottom-up. Examples of where costs are built from the bottom-up would be in manufacturing where absorption costing or activity based-costing techniques are used. These techniques would necessarily reflect the output level in the budgeted costs. This would permit direct and meaningful comparison of actual costs to budgeted costs for the same level of output. Variances can then be explored and attributed to rational causes such related to performance such as efficiency rate variances, labour rate variances, material price variances, etc.
-Thus fixed budgeting is not adequate for performance management where then umber of units produced is relevant.
-However, it is relevant where the cost driver is not volume of units produced but the outcome sought e.g. safe and clean environment, maintain reputation, maintain competitive capability through innovation (research and development), shared services e.g. head office.
Flexible budgeting
-Allows for variable levels of output e.g. 1000, 1500, 2000 cars over the planning period.
-Forecasts and budgets costs accordingly / -Overcomes the weaknesses of fixed budgeting by allowing budgeted costs to vary with the level of output so that the actual costs for the attained level of output can be compared to the relevant budgeted costs for the same level of output.
-The variances thus obtained can be more meaningfully interpreted.
-Flexible budgeting costs are built from the bottom-up by means of absorption costing, activity-based costing and other methods of budgeting that allow costs to be determined for variable levels of output.
-It is particularly useful in situations where the management of costs has priority over other performance management objectives such as product development, search for new markets, innovation, research and other circumstances where there is a high level of discretionary spending.
-Examples of circumstances where flexible budgeting would be appropriate include: i) early stages of a product’s lifecycle (costs are monitored carefully to determine whether the investment is worthwhile and to cut losses if it is not); ii) harvest stage of a product’s lifecycle (costs are monitored very carefully as margins are squeezed by intense competition and unnecessary costs are ruthlessly eliminated), iii) mature stage of a product’s lifecycle (further investments cannot be justified unless they extend the lifespan of the product as in convergence or geographical expansion of markets for the product.)
-Examples of where flexible budgeting would not be appropriate would be where there is a high degree of discretion over spending or spending is statutorily imposed: i) research and development; ii) head office costs, iii) environmental costs
Rolling budget
-Has fixed number of periods e.g. 12 months, 3 years
-Expired periods are replaced by new periods
-Continual renewal of the amounts
-Makes them relevant to strategies / -The aim of rolling budgets is to overcome the criticism that budgets go out of date and the amounts are not relevant for decision making.
-In resetting the budget for a revised three year period, the assumptions are retested in the light of changing environments. The latest strategic management information is used for that purpose. Other relevant information from analysis of the environment is also used.
-This helps to keep budgets relevant and useful.
Assess how budgeting may differ in notforprofit organisations from profitseeking organisations. [3]

Focus notes:

-value drivers: budgets used for raising funds from various donors

-project based budgets:need to appeal to funders; mixed funding and restrictions requires separation for accountability

-accountability requirements: clear goals, objectives, performance budgets

-fiduciary duty: input/output relationship

-stability: strategic plans

  1. Successful fund raising efforts drive not for profit organisations. Often budgets are used to raise funds particularly from institutional donors who are very specific and restrictive as to what they would fund. Budgets tend therefore to be project and activity based specifying sources of funds and expenditure commitments. This can be motivating as managers preparing budgets often establish a commitment to the project based on the relationships developed with funders and beneficiaries of funds. For example, a manager seeking funds for aids victims would be strongly motivated to maximise fund raising by exploiting all potential sources of funds.
  1. Accountability is a key issue for not for profit organisations as funders need to be convinced that best value is being provided for beneficiaries with the funds. Resources are allocated to activities based on clear input output relationships and performance indicators are determined based on the anticipated outcomes. These performance budgets provide a basis for measurement and evaluation of performance to assess the impact of the project.
  1. Just like profit organisations not for profit are also concerned about stability, risk and uncertainty and therefore carry out strategic management and three to five year forecasts.

Evaluate the issues raised by advocates of ‘beyond budgeting’. [3]

Focus notes: