BUYING INTO THE BUDGET
Why is it still so hard to engage line managers in the annual numbers game?
By Don Durfee

It’s a warm November day on the plains of west Texas, and Dale Hosack, the 47-year-old CFO of bottle-maker Western Container, has just finished an amiable conversation with two of his company’s factory managers.

Hosack is in a good mood – surprising, given the time of year. At US-based Western Container, November is the heart of budget season, the annual endurance contest many executives and employees dread all year. It’s understandable. The budgeting process is often a descent into frustration, punctuated by long conference calls, high-decibel discussions, and a tug-of-war between the finance department and business managers.

Indeed, until three years ago, executives at Western Container, a division of Coca-Cola Enterprises, grappled with a “monstrosity of a budget” that took the form of a 52-tab Lotus 1-2-3 spreadsheet. Operations managers disliked the planning process – and it showed. The budgets they submitted were often unrealistic or riddled with errors. Worse, they believed that corporate finance didn’t value their input. “We’d spend all this time on our budgets, but someone at a higher level would just stick in numbers they thought made more sense, without any dialogue with us,” says Bill McDonald, the company’s director of operations and formerly the general manager of Western Container’s factory in the US state of Mississippi. “It was their budget, but we were held responsible.”

That began to change when Hosack was hired as finance chief in 2003. He bought a new budgeting system from Microsoft (Forecaster) and changed the process to give general managers more say over the final numbers. Today, finance spends less time fixing broken spreadsheets and more time talking with operations about its needs and assumptions. And as general managers see finance more willing to listen, they take the process more seriously.

As a result, projections are more accurate and operations budgets contain fewer mistakes. Moreover, because the final document reflects their input, plant managers take ownership of the targets, says Hosack. “I no longer hear, ‘That’s not my number.’”

Thousands of miles away, in tropical Bangalore, India, Infosys is doing something similar. Led by CFO V Balakrishnan, finance employees at the US$2.2 bn information technology firm guide line managers through a bottoms-up budgeting process. Business managers – who, after all, have a clearer picture of their business prospects than headquarters executives – submit their revenue targets and the list of expenses they feel will be required to produce that income. Members of the finance team then spend between three and four hours with each manager to discuss the numbers in detail. “It’s a two-way conversation from the beginning,” says Balakrishnan. “For the budgeting process to work, we need to understand what the line managers want, and why they want it.”

Western Container and Infosys are achieving what CFOs have attempted for years: relevant and accurate budgets. Most corporations still don’t come close. For all the talk about better budgeting, the budgeting process remains a terrifically flawed pursuit, one that US benchmarking outfit APQC says takes the average company 60 days to complete.

In the typical budget tango, executives push hard for revenue and profit goals – in theory to challenge operations, in practice to please shareholders. Then line managers push back – in theory to reflect the reality of the market, in practice because bonuses are so often linked to budget targets. And so it goes, until everyone involved in the dance is as mistrustful as they are exhausted.

Every finance chief has run into this problem, says David S Smith, CFO of Standard Microsystems in the US. “No one likes to talk about [the lack of input from line managers],” he says. “With all the advanced technology we have, you would think something that sounds so simple would, in fact, be easy.”

Engaging the Line

It isn’t, a fact that can be seen in a new poll of finance managers conducted by CFO magazine in the US, and The Buttonwood Group, a performance-management consulting firm. According to the survey of 150 finance executives, fully 57% say line managers at their businesses do not personally key in their budget data. Further, very few have managers who provide variance explanations without help from finance.

Admittedly, these statistics may not capture the full extent of line-manager participation in budgeting. They do speak volumes, however, about the quality of budgets currently being produced by businesses. The truth is, engaging line managers in planning isn’t merely an exercise in corporate kumbaya. Unlike senior executives, employees who work in the field possess firsthand knowledge of what’s really going on at a business. They know what customers want, how long a piece of machinery will last, and where the opportunities for cost savings lie. Says Jean Nitchals, a senior financial analyst at US electronics retailer Best Buy: “There is a gap between what the store managers know about their operations and what corporate knows.” Eager to bridge that gap, Best Buy’s senior officers have already pushed planning out to the company’s district managers. Nitchals says store managers will eventually be included in the budgeting process as well.

Siew-Quen Thong, Asia-Pacific CFO for Texon International, also wants to inject line manager expertise into budgeting. When she joined the UK-based structural component manufacturer in 2004, line managers were disenchanted with the budget process. Plans were top-down: corporate set the revenue targets and required managers to explain how they’d meet them. Managers filled in finance’s budget forms haphazardly and felt little ownership of their budget targets. “It was a little chaotic,” admits Siew-Quen. “It was hard to hold anyone responsible for the targets if they didn’t feel like the numbers were theirs in the first place.’”

She decided to engage the managers earlier. The finance team created a set of key performance indicators and began sharing the data with managers weekly. Managers receive regular updates on cash flows and those at director level or above can see how their budgets fit in with the corporate numbers. At budget time, finance sits down with the managers and helps them develop the revenue and cost targets. “If the numbers are just coming from the finance team, then the operations managers don’t feel like the budget adds value to their work,” she says. “But now they own the numbers and are much more interested in tracking the results for us.”

Business-process consultants have long noted that when line managers have a hand in planning – as they do at Texon – budgets get better. That appears to be especially true when managers actually key their own numbers into the system. Respondents to the CFO/Buttonwood survey reported that when budget holders don’t type in their own numbers, more than 40% of submitted budgets have errors and omissions; when budget holders do their own inputting, the error rate falls to 28%.

At first glance, this result is surprising; common wisdom holds that nonfinance managers are more likely to make mistakes. But Lawrence Serven, a principal with Buttonwood, argues that this finding merely illustrates the perils of failing to engage line executives in budgeting. “We in finance have always thought about formula errors,” acknowledges Serven. “But when [corporate] is interpreting the needs of operations, there are errors stemming from miscommunication and misunderstanding.”
Hence, when a manager asks finance to raise his travel budget by 5%, finance may add 5% to the transportation general-ledger account, but neglect the meal or hotel accounts.

That, on a larger scale, is what can happen to budgets when finance or senior management drives the process. Because corporate doesn’t understand local issues as well as line managers, even well-intentioned efforts to create budgets on their behalf are likely to be a poor reflection of reality. “When the business-unit CFO is the only one working on the plan, it’s going to be a bad budget,” says Joseph M Leone, CFO of US consumer- and commercial-finance company CIT Group.

And, of course, it’s especially true when senior management unilaterally adjusts line managers’ numbers to suit the corporate mandate.

Term Limits

Why is it so hard to build a bridge between finance and operations? Much of the problem lies with differing points of view. Finance managers look at longer term (typically annual) goals. By necessity, line items in the corporate budget are broad, since they aggregate costs and revenues across disparate businesses. Business managers, by contrast, focus on actually carrying out their strategies. Their plans are typically short-term, specific to the business, and project-related.

“As an author of a budget, I don’t think in the same terms as accounting people,” says Joe Puglisi, chief information officer of EMCOR Group, a specialty construction and facilities-management company in the US. “I think about project-oriented costs and benefits, because that’s how you determine your return on investment.”

But since finance needs numbers that fit neatly into general-ledger categories, department heads often have to look across individual projects, breaking out what items get charged to the general-ledger code for transportation, what goes into the office-supplies category, and the like. It’s slow and unrewarding work.

One solution: rejigger the budgeting process to make it more intuitive to line managers while still providing the big-picture data that finance needs. Best Buy is starting to do this. The retailer spent four years overhauling its approach to planning. Previously, corporate officers made broad assumptions about the needs and capabilities of the company’s stores – and budgeted accordingly. Now, senior management gets that information directly from those in the trenches. An important part of this, says Nitchals, was designing operational metrics that make sense to the business operators but also have an impact on corporate results. “We in finance act as a mediator, translating the results of their metrics into financials,” she says.

The metrics for Best Buy’s call centers illustrate the approach. Finance employees conducted extensive interviews with the managers and business analysts who oversee the customer-service operation. Finance managers determined that it wasn’t enough to merely measure the costs of running a call center. They decided that Best Buy should track the factors that affect those costs. These are numbers that are already familiar to call-center managers, things like the time that operators spend on the phone with customers or whether calls come from users of the company’s website or customers who shop in its stores. The measures give an early indication of the costs the call centers will incur and are more useful for managers hoping to achieve their budgeted targets.

Managers and analysts enter the data directly into the company’s budgeting system, where it can be converted into financial measures that are used in the budget. “This is really activity-based costing,” says Best Buy’s vice president of finance Marc Gordon, “with an eye toward predictive ability.”

Another solution: make the budget more dynamic and thus more valuable to line managers. Infosys started doing this back in 2001, after the economy’s downturn took predictability out of the technology business. At the time, the company found that clients themselves had begun allocating their software budgets quarter by quarter. To match this reality, Infosys supplemented the annual budget with a series of rolling forecasts. “The budget used to be static, but now it’s reset every quarter,” says Balakrishnan.

That means that today, instead of annual targets that don’t budge despite changing business conditions, the company has flexibility. If demand is stronger than expected, then senior management can allocate more money to sales and marketing to capture the additional revenue. Conversely, Infosys can pare back on costs when business is slow. That’s good for business managers, who no longer have to labor under budget targets that may be hopelessly out of date. It also gives them more opportunities to get the resources they need. “For the line managers, the budget now reflects ground realities,” says Balakrishnan.

Ledger Domain

In theory, budgeting-and-planning (B&P) software is a good way to draw managers more deeply into the process. Often browser- or portal-based, the programs enable users to analyze current and historical corporate data and create business models based on different scenarios. Once clunky and difficult to navigate, the applications (from vendors like Microsoft, Hyperion, Cognos, SAS, and others) have gotten more powerful and easier to use in recent years.

That’s a winning combination, but apparently not one that has won many converts outside of finance departments. While many companies have purchased licenses allowing nonfinance managers to use B&P software, the CFO/Buttonwood survey found that those licenses are largely going unused. In fact, according to the survey, 40% of nonfinance users never logged in to their employers’ B&P systems during the past year.

Part of that reluctance may come from a fear of technology. It may also stem, in part, from the gap between what finance needs and what operations wants. Like the budgeting process itself, most B&P systems mirror the CFO’s view of the company: an Excel-like grid with general-ledger items running down one side. “It’s accountants who buy these tools, so it’s not surprising that the software resembles the spreadsheets they like,” says Serven. In fact, in recent years vendors have worked to make their programs look and feel more like Excel (a potentially worrisome trend, given that many managers aren’t adept at Excel; see sidebar, facing page).

EMCOR has neatly prevented that problem by adopting B&P software (BudgetPak from XLerant) that lets operations executives enter costs and revenues in terms that make sense to them: by project. Instead of the spreadsheet grid, the program asks a user a series of questions. The application then takes those numbers and rearranges them into the general-ledger codes that finance needs.

It’s also helpful to encourage operational managers to think more like CFOs. At Infosys all line managers must attend the company’s leadership institute. There, they receive training in finance, with a focus on the metrics included in corporate-level budgets. “You can talk to any manager and find that they all understand concepts like operating margin,” says Balakrishnan. “We can see the results of that understanding at budget time.”

Cops and Robbers

It’s the bonus-to-budget connection that really skews the process. “In budgeting, the guy who wins is the one who is best at gaming the system,” contends Steve Player, program director for the Beyond Budgeting Roundtable. “Finance is supposed to be a helper of the line, but budgeting turns us into corporate cops.”

Player’s prescription is radical: do away with the annual budget. In its place, he advocates using a continual-planning model, under which a company might use rolling forecasts and a regularly updated plan. This leaves managers more flexibility in responding to opportunities as they crop up. He also recommends decoupling incentive pay from budgeted targets. Instead, he says, companies should reward managers for true value creation. For example, bonuses might depend partly on sales growth relative to peer companies.

“In most cases, we pay maximum bonuses for poor performance,” says Player. “If we planned to have a 10% sales increase, but the market grew 20%, we’ve eroded market share.”

Of course, few managers are prepared to ditch the annual budget just yet (although some major companies, including American Express, have recently done just that). But most CFOs would probably agree with Player’s broader point that budgeting as it’s practiced today does a poor job of improving business results.

It doesn’t have to be that way, argues Serven. “We tend to think of budgeting and planning as a necessary evil, like filling out tax returns,” he says. “But if we treat it as a management exercise, it can be enormously valuable, both to the company and to the individual budget holders.”