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| David Cuykendall www.accountinglogics.net |
Most companies make budgets for three very different reasons; target setting, forecasting and resource allocation. Those budget numbers represent a set of targets, a forecast of what the future might look like, and an allocation of resources for next year. But these are all different things. The three purposes can’t meaningfully be handled in one process resulting in one set of numbers.
Analogies in Budgetary Control Systems
The only information available for forecasting is what you planned to happen, what actually happened, and the rate or means in which it has been happening. Consider an analogy expressed as a car driving down the highway with the windshield painted over.
Event Driven Planning and Budgeting
At the core of performance management is the planning and budgeting process. For most companies plans and budgets are negotiated, annual and fixed. Nothing is more likely to stifle adaptive and innovative management than this rigid, sterile process that clobbers the ability to marshal unity of effort throughout the enterprise.
There are two dated paradigms about financial information: (1) All users of cost and other financial information need the same kind of information; and (2) Cost information is only based in accounting transactions that are traced to a general ledger account.
Risk does not exist by itself. Risk is created when there is uncertainty. If I am certain that it is going to rain this afternoon, then there is no risk of rain. It's going to rain with 100% probability. There is no uncertainty about the forecast of rain.
The Basics of Dynamic Resource Allocation
Each business activity must go through a fixed number of stages. Payoffs accrue at the end of each business activity, depending on the quality of output. When maximizing the expected payoff of a portfolio of business activities, it is always optimal to work on the business activity with the highest expected payoff.
Most planning and budgeting systems involve plans, targets and resources that are negotiated, annual and fixed. Few managers know how to change their systems so that they become naturally responsive to change. This inability to cope with discontinuous change is rooted in an ingrained belief in ‘predict and control.’
Absolute control systems follow the general framework of control systems, yet are distinct in that the control system is not a circular process; there is no feedback loop that links back to redefine standards. Cyclic control systems are distinguished from absolute controls systems is that it is routine to reassess and possibly redefine the definition of the baseline cost or schedule.
