ALTERNATIVE BUDGET FORMATS AND BUDGET & CONTROL REFORMS

BUDGETING & PERFORMANCE RESPONSIBITY BUDGETING ENTERPRISE RESOURCE PLANNING BALANCED SCORECARDS Next page

BUDGETING & PERFORMANCE

Performance Is there a relationship between budgets and performance?

What is it?

Next page

Oregonians using the INTERNET Weakening of some K-12 achievement trends

10 8 3 rd Grade Math 6 HS Dropout 4 Advanced Degrees 2 Internet Use 0 7 6 5 4 3 2 1 0

Is Oregon making progress?

2003 2005 Yes •3 rd Grade Reading •College completion 8 th Grade Reading Computer Usage Yes, but No, but Labor Force No Training

How Oregon Compares

Better Similar Worse 3 rd 3 rd Grade Reading Grade Math High School Completion (25+) College Completion (25+) To Washington State Next page To U.S. Average

Questions

• What do

we

believe about the link between budgets and ensuing organizational (Biz/Govt/NFP) performance? • What is the nature of the evidence or support for these beliefs? • What are the implications for practice and research based on the findings? Jump to first page

1.

2.

3.

4.

5.

6.

Ten Things we Believe

(we = Fred and Ken)

Budgets focus attention –

usually on some target

Targets should reflect agreement on what adds value 7.

Unit cost targets can distract from focus on organization performance; *ROI* targets focus on balancing cost and organization performance

Ex-ante

budgets focus on spending targets

8.

Ex-post

budgeting increases internal conflict

Ex-post

budgets [e.g., Responsibility Budgets]focus on performance targets Stable targets focus attention on hitting the target 9.

10.

Conflict can be mitigated –

preferably via ethical argument?

Improved performance comes from learning a-

(Learning requires both perturbation and measurement)

Any target that can be achieved 100 percent of the time is too easy

b

-

(More iterations produce more opportunities for learning)

ROI is return on investment - requires difficult, but possible, discussions to define in Govt/NFP org’s.

Jump to first page

Budget Formats: Ex Ante Budgets

Alternative Budget Formats and Associated Features

Format Characteristics Primary Organization Feature Orientation Line item Program

Expenditure by commodity or resource purchased

Performance

Expenditure by workload or activity

Presentation of unit cost by activity

Expenditure related to public goals

Cost data cross organization lines

Resources purchased Tasks, activities accomplished Achievements, final products, outcomes, or consumer outputs Control Management Planning

Jump to first page

Flow of Public-Service Provision

Inputs

Labor, equipment, structures

Activities, tasks, outputs

Streets patrolled, bridges repaired, inspections made

Results

Safe and speedy transportation, security of people and property

Well-being of people

Street Repair Illustration

Input (line items)

Tons of hot mix Tons of cold mix Tons of crushed stone

Performance of tasks

Number of chuckholes filled Square feet resurfaced

Outcome data

Reduction in commuting time Reduction in accidents and associated costs Reduction in vehicle structural damage Jump to first page

These Are ALL Spending Budgets!

Managers are responsible for In the language of Responsibility executing the Budgeting, these are budget as enacted Little discretion to all expense budgets OE & Program Budgets are Discretionary acquire assets; no discretion to Performance Budgets exceed Expense Budgets are Engineered authorized Expense Budgets spending levels Jump to first page

They ALL Promote a BUDGET MINDSET

Jump to first page

• • • • •

Budget Mindset

Focus on inputs (instead of outputs) Emphasis on securing bigger budgets and more spending authority. Budget authority is AN ASSET Emphasis on spending rates, i.e., obligating budget authority by the end of the fiscal year Centralized budget decisions Little or no knowledge/understanding of costs -- or accountability for them Jump to first page

Performance Mindset

• Emphasis on outputs (instead of inputs). Budget authority is A LIABILITY • Manage both operational and financial performance • Focus on knowing and understanding the costs of outputs • Reward people for leadership in meeting operational performance and cost reduction targets • Decentralize performance and cost management decision authority Jump to first page

Budget History: Public and Private

Budgets, in the form of spending plans, are associated with development of bureaucracy and functional organizations Budgets, in the form of targets, are associated with business Next page

The Rise of Bureaucracy

Perfected by Prussians during 19th Century

• detailed centralized materials requirements and logistical planning ( INPUT/EXPENSE BUDGETS ), • control by rules, standard operating procedures, and the merit principle, • functional administrative design, distinction between staff and line • decomposition of tasks to their simplest components, • Sequential processing.

Jump to first page

Bureaucracy

Results

• made large, complex organizations possible; also made them inevitable • POSDCORB functions were all treated as separate concerns, performed by staff specialists and coordinated by TOP MANAGEMENT • substantial staff resources needed to gather and process data for TOP MANAGEMENT to coordinate activities and allocate resources Jump to first page

Moving away from Bureaucracy/GM

Multi-product, or M-form, organizational structure • each major operating division serves a distinct product market Decentralized control • by the numbers, using the DuPont system of financial controls, return-on-assets target Coordination • • short run via transfer prices Long run via modern capital budgeting system Jump to first page

Responsibility Budgeting

The most common decentralized control system used by large-scale organizations in the private sector. (a) units and managers are evaluated relative to the targets they accept, (b) only financial measures are used to measure and reward accomplishment or punish failure, and (c) financial success or failure is attributed entirely to managerial decisions and/or employee performance.

Jump to first page

Types of Responsibility Centers

Discretionary & Engineered expense centers (budgets are spending plans) Revenue centers (intermediate form) Cost centers (budgets are performance targets)

Standard cost centers Quasi-profit centers

Profit centers (budgets are performance targets) Investment Centers (budgets are performance targets) Jump to first page

Responsibility budgets I

For expense centers the budget is a spending plan

•

For discretionary expense centers, fixed spending targets

•

For engineered expense centers, flexible spending targets (i.e., the budget has two components, a discretionary component and a component that varies directly with volume)

Jump to first page

Responsibility budgets II

For a cost or profit centers the budget is a performance target or goal

• For cost centers, the target is a unit-cost standard • For quasi-profit centers, the target is a quasi-profit measure: (Standard Cost [units delivered] – Actual Unit Cost [units delivered]).

Jump to first page

Responsibility budgets III

For profit centers, the budget is a profit target [revenue – cost of goods sold.] The budget of an investment center is also a target or goal – usually return on assets [ROA or ROI] or residual income [EVA or RI]

The main difference between investment centers and all other responsibility centers is that the former approve their own capital budgets

Jump to first page

Capital budgeting I

is concerned with changes that have multi-period consequences for the responsibility center in question

e.g. investment in new plant or equipment, a new program, a major process enhancement, etc.

Where cost and profit centers are concerned, some higher authority must approve these kinds of projects.

And, each time a project is approved, the targets for the current period should be adjusted accordingly, as should future year targets.

Jump to first page

Capital budgeting II

IN CONTRAST, investment center mangers make these kinds of decisions without the approval of a higher authority. Their budgets are expressed in terms of their skill in managing assets: ROA, EVA.

Jump to first page

Formerly, individual production units were typically standard cost centers ; staff units were typically discretionary expense centers . Mission centers were investment centers .

Mission centers in private sector organizations produce final products that are easily priced and that are expensed following generally accepted accounting practice.

In contrast, support centers [e.g., staff units] produce intermediate products and these were, until recently, hard to cost, let alone price, with accuracy. Attempts to do so were often either excessively arbitrary or prohibitively costly.

Jump to first page

Beyond responsibility budgeting

Cycle-time burdening Cost of Quality Analysis Balanced Scorecards BPR Next page

Modern Control Methods

New developments in management control techniques/Responsibility Budgeting & EVA aren’t good enough (DF/DI) Businesses in Japan and Germany were producing higher quality goods and services at a lower cost:

JIT, Cycle-time analysis, Cost of Quality Analysis, Balanced Scorecards, and the Rules of BPR

Jump to first page

• • • • •

The German Critique (ABC)

Narrow rather than comprehensive (making things vs. making money) Uses wrong cost drivers (labor burdening) Unwillingness to rely on statistical cost measures and estimates Poor averaging, especially temporal averaging Failure to distinguish between needs of financial reporting and management control Jump to first page

The Japanese Critique I

• Importance of inventories and overheads , insignificance of labor hours • Quality • Solution: manage product design Cycle time process through and process value management so as to minimize the discrepancy between Process time and [inefficiency = 1 – (PT/CT)] Jump to first page

Process value analysis (PVA)

• Chart the flow of activities create , and deliver a service needed to design , • For each activity and step within the activity determine its associated cost and its cause • Determine how the step adds value non-value adding, identify ways to eliminate it and its associated cost; or, if it is • Determine the cycle time of each activity calculate its cycle efficiency time/total time); and (value-added and • Seek ways to improve cycle efficiency reduce associated costs due to delays , excesses , and unevenness in activities.

and Jump to first page

Business Process Reengineering

Jobs should be designed around an objective or outcome instead of a single function.

Functional specialization and sequential execution are inherently inimical to expeditious processing.

Those who use the output of activity the activity should perform and the people who produce information should process it greatest need for information and the greatest interest in its accuracy.

, since they have the

Information should be captured once and at the source.

Parallel activities should be coordinated during their performance, not after they are completed.

The people who do the work for decision making designs.

and should be responsible control built into their job Jump to first page

BPR reflects assumptions of flexible or lean production (JIT)

• • • • Nobody but the front-line worker adds value (directly).

Front-line workers can perform most functions better than specialists (lean manufacturing).

Every step in the value chain should be done perfectly (TQM).

This reduces the need for buffer stocks and produces a higher quality end product or service.

Jump to first page

BPR reflects modern IT: reduced economies of scale and scope

• • • • Multidisciplinary teams, members work together from start of job to completion Push exercise of judgment down to teams that do an organization's work More equal distribution of knowledge, authority, and responsibility Average firm size falling for the last twenty years (SIC) Jump to first page

The Balanced Scorecard

Four perspectives ………………………………….

• • • • Financial Customer Internal Business Processes Learning and Growth Perspective Jump to first page

Jump to first page

• • •

Learning Critique

Improving performance requires learning Learning requires dialogue About purposes, goals, cause-effect relations • Opportunities for learning • Measurement, alternative measurements • Experimentation (perturbation) Jump to first page

Summary

Jump to first page

1.

2.

3.

4.

5.

6.

Ten Things we Believe

(we = Fred and Ken)

7.

Budgets focus attention –

usually on some target

Targets should reflect agreement on what adds value

Ex-ante

budgets focus on spending targets

Ex-post

budgets [e.g., Responsibility Budgets]focus on performance targets Stable targets focus attention on hitting the target Any target that can be achieved 100 percent of the time is too easy

8.

9.

10.

Unit cost targets can distract from focus on organization performance; *ROI* targets focus on balancing cost and organization performance

Ex-post

budgeting increases internal conflict Conflict can be mitigated –

preferably via ethical argument?

Improved performance comes from learning a-

(Learning requires both perturbation and measurement) b

-

(More iterations produce more opportunities for learning)

ROI is return on investment - requires difficult, but possible, discussions to define in Govt/NFP org’s.

Jump to first page

Practicum

Responsibility budgeting AFMC General George Babbitt Next page

Presentations

• •

Group 1

What coalition came to support the initiation of cost management? Why did this base of support coalesce?

Jump to first page

Presentations

• • •

Group 2

How did the idea of cost management come into existence? What reasoning and persuasive rhetoric were involved in selling it? What was it about the people or the situation – including historical background – that influenced the eventual idea? Jump to first page

Presentations

• • •

Group 3

Who were the managers?

business-area

What was their part in the cost management system?

Why did

they

apparently perform their roles in general accord with the design of AFMC’s “cost management system”? Jump to first page

Guidelines

• • •

A presentation should be crisp – not to exceed 10 minutes Any case facts should be presented within the context of the reasoning/argument Prepare for questions

Jump to first page