SOURCE: Kay Sever | October 2, 2020
A REVIEW OF A STANDARD BUDGET PROCESS
Executives and management teams use actual and budget data to make decisions, make money and measure success. Each year the company PLANS for next year’s productivity, cost and profit. These planned targets are often formulated based on past or current performance trends; other factors such as the economy, competition, supply chain or regulations are also considered.
Many man-months are spent discussing and finalizing the target values linked to the operating plan. Towards the end of the budgeting process, some executives build “stretch” into budget targets to challenge the employees to do better than the approved budget’s targets. In a “stretch” budget, a final set of numbers are agreed to without “stretch” built in. Then target values are “arbitrarily” raised (maybe 5-10%) over the baseline budget. The “stretch budget” may become the final budget OR it may be used as a second budget tier where additional bonuses will only be paid if “stretch” is achieved.
Once the budget is finalized and approved by top management, it is “frozen” and cannot be changed.
A QUICK ANALYSIS OF THE ABOVE SUMMARY
Numbers “frame” every management discussion about performance and “shape” the collective thinking of decision-makers as they formulate an operating plan for the coming year. Past performance and external factors are used to formulate numbers for next year’s plan/budget. Sometimes executives build “stretch” into budgets to find out if their people and assets can do a little more than budget. In every case, they can only make decisions about the numbers they see.
There is NO MENTION of data that quantifies what is possible to achieve (i.e., optimum performance). “Stretch” is not “best possible”… it is a percent increase from the plan. Why is optimum performance important to consider during the budget process? If they only see data for actual and plan, they can only make decisions within the context of those numbers. As a result, they will limit their questions to the relationship between those datasets as they try to assess the performance capabilities of their companies. Ironically, data for performance capabilities are NOT included in the data they use to set targets for the coming year.
WHEN BUDGET IS YOUR DEFAULT
Without data for “best possible” (optimum) performance, executives and management teams have no third data dimension to compare to when framing questions about operating/profit potential. They
1) CAN’T ASK (or answer) questions about HOW GOOD their assets, their people and their organization can be, regardless of the numbers placed in the budget.
2) MAY BE BUDGETING TO LOSE MILLIONS OF DOLLARS and not know it. Some of these losses could occur for years and not be stopped. A company I worked with met budget frequently, but had lost $17,000,000/year and did not know it. One of their budget targets hid the loss.
3) DON’T KNOW how to find excess process capacity. As a result, they could approve UNNEEDED plant expansions or MISPLACE expansion capital in the value stream… an expensive and embarrassing mistake.
4) CAN’T MEASURE the people/culture losses caused by CHOICES made when solving problems or working together. These choices can shape a corporate culture positively or negatively. Knowing the value of these choices can create urgency to change them, which stops the losses and reshapes the corporate culture simultaneously.
5) CAN’T ASSESS the gap between where they are today and their operating potential (i.e., upside).
6) CAN’T ACHIEVE their best possible (optimum) performance, even if they have purchased new equipment/systems for that purpose. There will always be a difference between optimum, budget and actual performance. Optimum/“best possible” values are not the same as “design specs” provided by OEMs). If management expressed a desire to “be the best” or to optimize results, they CANNOT achieve that goal without an optimum dataset strategically linked to assets, people and the management team. Without that dataset, budget becomes the inadequate DEFAULT for measuring their success.
In closing, remember this…
1) Optimization is a “steady operating state” reached when assets, people and the management team are all focused on achieving measurable “best possible” results.
2) New equipment and systems sold as “optimization solutions” will not deliver “plug-and-play” optimization to your company’s doorstep or sustain an optimization state into the future.
3) Management is responsible for connecting the assets, people and management system strategically to achieve and sustain full (site-wide) optimization.
Thought for the month: With no data for optimum performance, “budget becomes the default” for measuring your success, even if optimization is the goal.
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Kay Sever is an Optimization Management Expert who helps executive and management teams reach their optimization goals. She has developed a LIVESTREAM management training system for Optimization Management called MiningOpportunity – NO TRAVEL REQUIRED. MiningOpportunity modules teach executives and management teams how to strategically “upgrade” parts of their management system to remove barriers that steal profit, divide people and prevent optimization. Training will use your problems and examples to maximize learnings and accelerate change. Unique insights from Kay’s 3-year study of management’s barriers to change and optimization are included in the content. See MiningOpportunity.com for her contact information and several training options for your team, including the NEW “Spend a Day with Kay” option.