Handbook of Budgeting -  - E-Book

Handbook of Budgeting E-Book

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Beschreibung

No other management tool provides the operational direction that a well-planned budget can. Now in a new edition, this book provides updated coverage on issues such as budgeting for exempt organizations and nonprofits in light of the IRS' newly issued Form 990; what manufacturing CFOs' budgeting needs are; current technology solutions; and updated information on value-based budgets. Controllers, budget directors, and CFOs will benefit from this practical "how-to" book's coverage, from the initial planning process to forecasting to specific industry budgets.

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Contents

Cover

Title Page

Copyright

Series

Foreword

Preface

THE NEED TO IMPROVE YOUR BUDGETING PROCESSES

THE FORECAST ON BUDGETING

Part One: Introduction to the Budgeting Process

Chapter One: Integrating the Balanced Scorecard for Improved Planning and Performance Management

OVERVIEW

ELEMENTS OF A BALANCED SCORECARD

USE OF STRATEGY MAPS

SCORECARD CASCADING

BRINGING IT ALL TOGETHER

INTEGRATING THE SCORECARD WITH PLANNING AND PERFORMANCE

BALANCED SCORECARD AND ANNUAL PLANNING

CONTINUOUS STRATEGIC MANAGEMENT WITH THE SCORECARD

SUMMARY

Chapter Two: Strategic Balanced Scorecard–Based Budgeting and Performance Management

INTRODUCTION: WHY MOST COMPANIES FAIL TO IMPLEMENT THEIR STRATEGIES

WHY A FEW COMPANIES PRODUCE EXCEPTIONAL RESULTS

MEASURE YOUR STRATEGY WITH BALANCED SCORECARD

BALANCED SCORECARD–BASED BUDGETS

PERFORMANCE MANAGEMENT

SUMMARY

Chapter Three: Budgeting and the Strategic Planning Process

DEFINITION OF STRATEGIC PLANNING

PLANNING CYCLE

STRATEGIC PLANNING PROCESS: A DYNAMIC CYCLE

SITUATION ANALYSIS

BUSINESS DIRECTION/CONCEPT

ALTERNATIVE APPROACHES

OPERATIONAL PLAN

MEASUREMENT

FEEDBACK

CONTINGENCY PLANNING

PROBLEMS IN IMPLEMENTING FORMAL STRATEGIC PLANNING SYSTEMS

SUMMARY

Chapter Four: Budgeting and Forecasting: Process Tweak or Process Overhaul?

INTRODUCTION

SURVEY METHODOLOGY

FINDINGS: BUDGETING PROCESS

FINDINGS: FORECASTING PROCESS

REPORT SUMMARY

DEVELOPING A ROAD MAP FOR CHANGE

Chapter Five: The Budget: An Integral Element of Internal Control

INTRODUCTION

THE CONTROL ENVIRONMENT

PLANNING SYSTEMS

REPORTING SYSTEMS

SUMMARY

Chapter Six: The Relationship between Strategic Planning and the Budgeting Process

INTRODUCTION

HOW TO PLAN

THE AUDIENCE FOR WHOM THE PLAN IS DESIGNED

STRATEGIC BUSINESS PLANNING AND ITS ROLE IN BUDGETING

PLANNING DIFFERENCES AMONG SMALL, MEDIUM, AND LARGE ORGANIZATIONS

COMPONENTS OF STRATEGIC PLANNING

MANAGEMENT AND ORGANIZATION

MARKET ANALYSIS

FORMULATION OF MARKETING STRATEGIES

OPERATIONS ANALYSIS

SUMMARY

Chapter Seven: The Essentials of Business Valuation

INTRODUCTION

UNDERSTANDING THE VALUATION ASSIGNMENT

RESEARCH AND INFORMATION GATHERING

ADJUSTING AND ANALYZING THE FINANCIAL STATEMENTS

THREE APPROACHES TO VALUING A BUSINESS

INCOME APPROACH

MARKET APPROACH

ASSET APPROACH

MAKING ADJUSTMENTS TO VALUE

REACHING THE VALUATION CONCLUSION

Chapter Eight: Moving Beyond Budgeting: Integrating Continuous Planning and Adaptive Control

INTRODUCTION

ANNUAL BUDGETING TRAP

WHY SOME ORGANIZATIONS ARE GOING BEYOND BUDGETING

BEYOND BUDGETING: ENABLING A MORE ADAPTIVE PERFORMANCE MANAGEMENT PROCESS

CLIMBING THE TWIN PEAKS OF BEYOND BUDGETING

BEYOND BUDGETING: ENABLING RADICAL DECENTRALIZATION

Chapter Nine: Moving Beyond Budgeting: An Update

INTRODUCTION

BEYOND BUDGETING ROUND TABLE (BBRT)

GUARDIAN INDUSTRIES CORPORATION

Part Two: Tools And Techniques

Chapter Ten: Implementing Forecasting Best Practices

INTRODUCTION

BUDGETING VERSUS FORECASTING

IMPLEMENTING FORECASTING BEST PRACTICES

FORECASTING BEST PRACTICES: PROCESS

FORECASTING BEST PRACTICES: ORGANIZATION

FORECASTING BEST PRACTICES: TECHNOLOGY

CONCLUSION

Chapter Eleven: Calculations and Modeling in Budgeting Software

INTRODUCTION

WHY COMPANIES USE BUDGETING SOFTWARE

CALCULATIONS IN ACCOUNTING SYSTEMS AND SPREADSHEETS

BUDGETING SOFTWARE

OLAP DATABASES

MODELING AND BUDGETING

PROCESSES

MORE COMPLEX BUDGETING CALCULATIONS

CONCLUSION

Chapter Twelve: Cost-Accounting Systems: Integration with Manufacturing Budgeting

INTRODUCTION

DECISION FACTORS IN THE SELECTION PROCESS

COST-ACCOUNTING SYSTEM OPTIONS

COSTS ASSOCIATED WITH A PRODUCT

LABOR COST

VARIABLE COSTING AND BUDGETING

FULL COSTING AND BUDGETING

COST-ACCUMULATION PROCEDURES

VALUATION: ACTUAL VERSUS STANDARD

ACTUAL COSTING

ACTUAL COSTING, BUDGETING, AND COST CONTROL

STANDARD COSTING

VARIANCE REPORTING

VARIANCES AND BUDGETING

MANUFACTURING OVERHEAD

MANUFACTURING OVERHEAD, BUDGETING, AND COST CONTROL

Chapter Thirteen: Break-Even and Contribution Analysis as a Tool in Budgeting

INTRODUCTION

BREAK-EVEN ANALYSIS

PRICE/VOLUME CHART

CONTRIBUTION ANALYSIS

COST–VOLUME–PRICE AND THE BUDGETING PROCESS

Chapter Fourteen: Profitability and the Cost of Capital

INTRODUCTION

A MARKET GAUGE FOR PERFORMANCE

COPING WITH THE COST OF EQUITY

BUILDING COMPANY-WIDE PROFIT GOALS

BUILDING DIVISIONAL PROFIT GOALS

INFORMATION PROBLEMS AND COST OF CAPITAL

SUMMARY

Chapter Fifteen: Budgeting Shareholder Value

INTRODUCTION

LONG-TERM VALUATION

ECONOMIC VALUE ADDED

COMPLEMENTARY MEASURES OF VALUATION

BUDGETING SHAREHOLDER VALUE

SUMMARY

Chapter Sixteen: Applying the Budget System

INTRODUCTION

INITIAL BUDGET DEPARTMENT REVIEW OF DIVISIONAL BUDGET PACKAGES

DIVISIONAL REVIEW MEETINGS

BUDGET CONSOLIDATION AND ANALYSIS

PRELIMINARY SENIOR MANAGEMENT REVIEW

FINAL REVISION OF OPERATING GROUP PLANS

SECOND BUDGET STAFF REVIEW OF OPERATING GROUP PLANS

REVISED CONSOLIDATED BUDGET PREPARATIONS

FINAL SENIOR MANAGEMENT BUDGET REVIEW SESSIONS

OPERATING GROUPS’ MONTHLY SUBMISSIONS

EFFECTIVE USE OF GRAPHICS

SUMMARY

Chapter Seventeen: Budgets and Performance Compensation

INTRODUCTION

MEASURES OF EXECUTIVE PERFORMANCE

STRUCTURING REWARD OPPORTUNITIES

PITFALLS OF LINKING INCENTIVES TO BUDGETS

AN OPTIMAL APPROACH

ADJUSTING OPERATING UNIT TARGETS

BUDGETS AND LONG-TERM INCENTIVE PLANS

SUMMARY

Chapter Eighteen: Predictive Costing, Predictive Accounting

INTERNET FORCES THE NEED FOR BETTER COST FORECASTING

TRADITIONAL BUDGETING: AN UNRELIABLE COMPASS

ACTIVITY-BASED COSTING AS A FOUNDATION FOR ACTIVITY-BASED PLANNING AND BUDGETING

BUDGETING: USER DISCONTENT AND REBELLION

WEARY ANNUAL BUDGET PARADE

ABC/M AS A SOLUTION FOR ACTIVITY-BASED PLANNING AND BUDGETING

ACTIVITY-BASED COST ESTIMATING

ACTIVITY-BASED PLANNING AND BUDGETING SOLUTION

EARLY VIEWS OF ACTIVITY-BASED PLANNING AND BUDGETING WERE TOO SIMPLISTIC

IMPORTANT ROLE OF RESOURCE CAPACITY CAUSES NEW THINKING

MAJOR CLUE: CAPACITY EXISTS ONLY AS A RESOURCE

MEASURING AND USING COST DATA

USEFULNESS OF HISTORICAL FINANCIAL DATA

WHERE DOES ACTIVITY-BASED PLANNING AND BUDGETING FIT IN?

ACTIVITY-BASED PLANNING AND BUDGETING SOLUTION

RISK CONDITIONS FOR FORECASTING EXPENSES AND CALCULATED COSTS

FRAMEWORK TO COMPARE AND CONTRAST EXPENSE-ESTIMATING METHODS

ECONOMICS 101?

Chapter Nineteen: Cost Behavior and the Relationship to the Budgeting Process

INTRODUCTION

COST BEHAVIOR

BREAK-EVEN ANALYSIS

ADDITIONAL COST CONCEPTS

DIFFERENTIAL COST CONCEPTS

MAXIMIZING RESOURCES

ESTIMATING COSTS

SUMMARY

Part Three: Preparation of Specific Budgets

Chapter Twenty: Sales and Marketing Budget

INTRODUCTION

OVERVIEW OF THE BUDGET PROCESS

SPECIAL BUDGETING PROBLEMS

PERTINENT TOOLS

UNIQUE ASPECTS OF SOME INDUSTRIES

SUMMARY

Chapter Twenty-One: Manufacturing Budget

INTRODUCTION

CONCEPTS

CHANGING TO A COST-MANAGEMENT SYSTEM

PROBLEMS IN PREPARING THE MANUFACTURING BUDGET

THREE SOLUTIONS

TECHNIQUE

DETERMINING PRODUCTION REQUIREMENTS

STEP 1: DEVELOPING THE PLANNABLE CORE

STEP 2: OBTAINING SALES HISTORY AND FORECAST

STEP 3: SCHEDULING NEW AND REVISED PRODUCT APPEARANCE

STEP 4: DETERMINING REQUIRED INVENTORY LEVELS

STEP 5: ESTABLISHING REAL DEMONSTRATED SHOP CAPACITY

STEP 6: PUBLISHING THE MASTER SCHEDULE

A TOTAL QUALITY PROGRAM’THE OTHER ALTERNATIVE

INVENTORY AND REPLENISHMENT

MORE ON THE MANUFACTURING BUDGET

DETERMINING RAW-MATERIAL REQUIREMENTS

DETERMINING OTHER INDIRECT-MATERIAL COSTS

DETERMINING DIRECT-LABOR COSTS

ESTABLISHING THE MANUFACTURING OVERHEAD FUNCTIONS AND SERVICES

QUALITY CONTROL ECONOMICS REVIEW QUESTIONS

PLANT ENGINEERING BUILDINGS AND EQUIPMENT MAINTENANCE REVIEW QUESTIONS

FLOOR AND WORK-IN-PROCESS CONTROL REVIEW QUESTIONS

SUMMARY

Chapter Twenty-Two: Research and Development Budget

RELATIONSHIP OF RESEARCH AND DEVELOPMENT AND ENGINEERING TO THE TOTAL BUDGETING PROCESS

PROBLEMS IN ESTABLISHING RESEARCH AND DEVELOPMENT AND ENGINEERING OBJECTIVES

DEVELOPING A TECHNOLOGICAL BUDGET

PREPARING A DEPARTMENTAL BUDGET

MANAGING A BUDGET

COORDINATING PROJECT BUDGETS

Chapter Twenty-Three: Administrative-Expense Budget

INTRODUCTION

ROLE AND SCOPE OF THE ADMINISTRATIVE-EXPENSE BUDGET

METHODS USED FOR PREPARING THE ADMINISTRATIVE-EXPENSE BUDGET

FACTORS THAT IMPACT THE ADMINISTRATIVE-EXPENSE BUDGET

UNIQUE ISSUES IMPACTING THE ADMINISTRATIVE-EXPENSE BUDGET

TOOLS AND TECHNIQUES FOR MANAGING THE ADMINISTRATIVE-EXPENSE BUDGET

SUMMARY

Chapter Twenty-Four: Budgeting the Purchasing Department and the Purchasing Process

DESCRIPTION AND DEFINITION OF THE PROCESS APPROACH

ROLE OF PROCESS MEASURES

PROCESS MEASURES

CREATING THE PROCUREMENT PROCESS BUDGET

Chapter Twenty-Five: Capital Investment Review: Toward a New Process

INTRODUCTION

CONTEXT OF THE REVISED CAPITAL-INVESTMENT REVIEW PROCESS

BENCHMARKING CAPITAL-INVESTMENT REVIEW BEST PRACTICES

REVISED CAPITAL-INVESTMENT REVIEW PROCESS: OVERVIEW

IMPLEMENTATION: WHAT BONNEVILLE LEARNED IN THE FIRST THREE YEARS

SUMMARY

Chapter Twenty-Six: Leasing

INTRODUCTION

OVERVIEW OF THE LEASING PROCESS

POSSIBLE ADVANTAGES OF LEASING

POSSIBLE DISADVANTAGES OF LEASING

TYPES OF LEASE SOURCES

LEASE REPORTING

LEASE VERSUS PURCHASE ANALYSIS

FINANCIAL ACCOUNTING STANDARDS BOARD RULE 13 CASE ILLUSTRATION

NEGOTIATION OF LEASES

SELECTING A LESSOR

LEASE-ANALYSIS TECHNIQUES

LEASE FORM

SUMMARY

Chapter Twenty-Seven: Balance-Sheet Budget

INTRODUCTION

PURPOSE OF THE BALANCE-SHEET BUDGET

DEFINITION

RESPONSIBILITY FOR THE BUDGET

TYPES OF FINANCIAL BUDGETS

PREPARING FINANCIAL BUDGETS

PREPARING THE BALANCE-SHEET BUDGET

ADEQUATE CASH

FINANCIAL RATIOS

ANALYZING CHANGES IN THE BALANCE SHEET

Chapter Twenty-Eight: Budgeting Property and Liability Insurance Requirements

INTRODUCTION

ROLE RISK MANAGEMENT PLAYS IN THE BUDGETING PROCESS

TYPES OF INSURANCE MECHANISMS

ROLE OF INSURANCE/RISK CONSULTANTS

USE OF AGENTS/BROKERS

SELF-INSURANCE ALTERNATIVES

IDENTIFYING THE NEED FOR INSURANCE

KEY INSURANCE COVERAGES

IDENTIFYING YOUR OWN RISKS

HOW TO BUDGET FOR CASUALTY PREMIUMS

SUMMARY

Part Four: Budgeting Applications

Chapter Twenty-Nine: Budgeting: Key to Corporate Performance Management

FUTURE OF BUDGETING

ADDING VALUE TO THE ORGANIZATION

CORPORATE PERFORMANCE MANAGEMENT

DEVELOPING A BUDGET PROCESS FOCUSED ON IMPLEMENTATION OF STRATEGY

ROLE OF TECHNOLOGY

OVERCOMING ORGANIZATIONAL RESISTANCE

PLANNING AND CONTROLLING IMPLEMENTATION OF A NEW SYSTEM

CONCLUSION

Chapter Thirty: Zero-Based Budgeting

INTRODUCTION

PROBLEMS WITH TRADITIONAL TECHNIQUES

ZERO-BASED APPROACH

ZERO-BASED BUDGETING PROCEDURES

DECISION PACKAGE

RANKING PROCESS

COMPLETING THE PROFIT AND LOSS

PREPARING DETAILED BUDGETS

SUMMARY

Chapter Thirty-One: Bracket Budgeting

INTRODUCTION

APPLICATION OF BRACKET BUDGETING

PREMISES TO PROFITS?

DEVELOPING A TACTICAL BUDGETING MODEL

BRACKET BUDGETING IN ANNUAL PLANNING

CONSOLIDATING INCOME STATEMENTS

SUMMARY OF BENEFITS

SUMMARY

Chapter Thirty-Two: Program Budgeting: Planning, Programming, Budgeting

INTRODUCTION

DESCRIPTION OF PROGRAM BUDGETING

HISTORY

FRAMEWORK OF PROGRAM BUDGETING

PROGRAM STRUCTURING

TYPES OF ANALYSIS

INSTALLATION CONSIDERATIONS

SUMMARY

Chapter Thirty-Three: Activity-Based Budgeting

INTRODUCTION

TRADITIONAL BUDGETING DOES NOT SUPPORT EXCELLENCE

ACTIVITY-BASED BUDGETING DEFINITIONS

ACTIVITY-BASED BUDGETING PROCESS

LINKING STRATEGY AND BUDGETING

TRANSLATE STRATEGY TO ACTIVITIES

DETERMINE WORKLOAD

CREATE PLANNING GUIDELINES

IDENTIFY INTERDEPARTMENTAL PROJECTS

IMPROVEMENT PROCESS

FINALIZING THE BUDGET

PERFORMANCE REPORTING

SUMMARY

Part Five: Industry Budgets

Chapter Thirty-Four: Budgeting for Corporate Taxes

INTRODUCTION

TAXATION OF C CORPORATIONS

PERSONAL HOLDING COMPANY TAX

NET OPERATING LOSS UTILIZATION

CHARITABLE CONTRIBUTIONS

TAXATION BUDGET

FEDERAL CORPORATE TAX

PURPOSES

TAX RETURN

Chapter Thirty-Five: Budgeting in the Global Internet Communication Technology Industry

OVERVIEW

ESSENTIALS FROM EARLIER CHAPTERS

FREEMIUM STRATEGIES

VOLUNTEER SERVICES

ENTERPRISE RISK MANAGEMENT

About the Editor

About the Contributors

Index

Wiley End User License Agreement

Copyright © 2012 by John Wiley & Sons, Inc. All rights reserved.

The fifth edition of this book, titled Handbook of Budgeting, was published in 2003.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Handbook of budgeting / [edited by] William R. Lalli. — 6th ed. p. cm. Includes index. ISBN 978-0-470-92045-9 (cloth); ISBN 978-1-118-17059-5 (ebk); ISBN 978-1-118-17060-1 (ebk); ISBN 978-1-118-17061-8 (ebk) 1. Budget in business. I. Lalli, William Rea. HG4028.B8H36 2012 658.15′4–de23 2011029142

Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Asia, and Australia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding.

The Wiley Corporate F&A series provides information, tools, and insights to corporate professionals responsible for issues affecting the profitability of their company, from accounting and finance to internal controls and performance management.

Foreword

The idea of budgeting often brings fear, even loathing, to the minds of most persons. Perhaps that is because many of us were first introduced to the term by trying to figure out how to spend our seemingly unfairly small “allowances” as children. It was not easy to figure out how much candy we could buy and still go to the movies on the weekend. These days our children buy more movies (and video games) than they attend, but the principles (and the sweets) are the same.

In its simplest sense, budgeting is any plan, usually expressed in financial or mathematical terms. As an expression of expectations, a budget generally aligns resources with needs to accomplish a specific goal. As mileposts and measuring sticks, budgets provide invaluable benchmarks that can be used every day in reacting to management challenges.

Some see budgets as a necessary evil, but in reality they are underrated tools that can greatly enhance any business process.

The greatest value of budgets—arming management with key decision-making tools—is often overlooked. To the uninitiated, a budget succeeds or fails based on how close actual results compare to expectations. While it is great fun to predict the future accurately, to win a bet as they say, life’s best lessons are often learned in analyzing why you were wrong.

In reality, analyzing the reasons actual results differ from expected results is a far more useful tool than the often disappointing attempt to accurately predict the future. This cannot be done effectively without a budget to compare things to. Like the weather, financial futures are difficult to predict and sometimes correlate only with predictions as result of an accident, good luck or otherwise. Were these assumptions wrong? Were needs incorrectly calculated? Did the business environment change? Did the world change? Was a better method or process discovered? Were there unanticipated challenges? By studying what is different and the reasons for differences, we can continually improve both performance and our ability to predict the future. We have certainly come a long way in improving our ability to predict the weather, but expectations for accuracy have also increased. Similarly, the art and science of budgeting has advanced dramatically over the years since the handbook was first published. Revisions in this edition reflect alterations and improvements comparing these budgets to older ones.

Budgets are clearly not just for children to manage their allowances and meager earnings. They are not just for big businesses either, as some would incorrectly perceive. Budgets are for everyone.

In modern times, budgets are often (unfortunately) utilized only by midsize businesses when they are in trouble. They would likely be in trouble less frequently if they used budgets more often. Certainly there is less superficial need to manage resources when revenues seem to flow effortlessly well beyond the costs needed to sustain a business. The lack of need in these cases is invariably only superficial; easy money is a fleeting concept. Darwinian pressures on business provide survival only to the fittest and most prepared.

As can be learned by studying the various budgets in this book, time, money, and processes can be budgeted. Planning for the future enhances our understanding of the present. Budgets reduce the chances of repetition of past errors, and while nothing can prevent the commission of new errors or the introduction of new challenges, effective budgeting can lead to the preparedness necessary to deal with adversity and opportunity when either is on your doorstep.

This handbook is a resource that will help you identify the right type of budget to use and which tools to implement in actually completing the budget and provide insight into analyzing your budget against actual expectations.

David A. Lifson, CPACrowe Horwath LLP

David Lifson, CPA, is a partner with Crowe Horwath LLP and leads the New York City tax and business consultancy practice, where he develops business strategies and personal financial plans utilizing both his and the firm’s broad range of accounting, audit, tax, and business consulting backgrounds, both domestically and internationally. He specializes in advising clients on managing various types of business change within tax, economic, and other related constraints and dealing with the tax compliance challenges that accompany change. This includes starting or closing a business; buying, merging, or selling one; or trying to change or value an existing operation.

Mr. Lifson is the recipient of the American Institute of CPAs 2009 Arthur J. Dixon Memorial Award, the accounting profession’s highest award in the area of taxation. He has chaired the Tax Executive Committee, served as a member of the AICPA Board of Directors and on its council, and has chaired or served on various committees, task forces, and technical resource panels over the years. He is also a former president of the New York State Society of CPAs and has served in various capacities on its behalf. Mr Lifson has chaired the Small Business and Self Employed subgroup of the Internal Revenue Service’s Advisory Council (IRSAC) while serving on the council. IRSAC meets regularly to advise the Commissioner of the IRS and key IRS group leaders on how to administer the tax system effectively.

Preface

THE NEED TO IMPROVE YOUR BUDGETING PROCESSES

Despite advances in technology and finance, we have not reached the limit of knowledge or made the most advanced achievements in reaching our financial goals. That is a definition of a frontier that we face in these times.

There are many types of budgeting, and most of them are covered in this book. The need for sound, dependable information as the basis for quality decision making based on reliable budgets, I contend, has never been stronger. That is the reason I proposed revising this book to present this sixth edition of the Handbook of Budgeting.

I could report on the state of the economy and economic trends, citing a variety of sources and experts; however, my only point is that in bad times more than in good times, budgeting can be key to an entity’s survival or prosperity.

This book is intended as a business tool. I shall leave it to the academicians to analyze what might work better. Instead, our authors present 35 chapters of tried-and-true experiences taken from frontline business exposure that will enlighten you as to how you may incorporate real changes in your environment.

I became the second editor of this book after its founding editor died. One reason I was selected to replace him was due to the extensive work I was doing at the time in the budgeting area for delivering continuing professional education to senior financial executives. One day at a conference, an attendee approached me, realized I was the book editor, and paid me the highest compliment I ever received. She told me that she worked with a copy of the book open on her desk.

There is no outer limit in any field of endeavor, especially one in which the opportunities for research and development have not been exploited. This is the new frontier that must be met with technology and information management in finance in modern times which companies must master in order to survive and prosper. Use every tool at your disposal.

THE FORECAST ON BUDGETING

The Handbook of Budgeting has been revised in this sixth edition to retain some “evergreen” knowledge from previous contributors, augmented by new experts on new topics.

More contributions from corporate perspectives translate into more opportunities for you to take this information to your team and to implement the lessons this book contains company-wide.

Chief financial officers, chief information officers, chief operating officers; vice presidents of fnance; controllers and assistant controllers; directors and managers of budgeting, forecasting, financial planning, analysis, business planning, strategic planning, performance measurement, and finance; financial consultants; budget analysts; and financial analysts will all find that this book has been designed with their specific needs in mind.

Our contributors and I believe that budgeting is the most important component of an overall dynamic business planning process. When it is combined with available technology, you may quickly analyze its impact on your business, which will lead you to more effective decisions that improve the profitability of your company.

Please note that the term “budgeting” is used in its broadest context and includes the major process components of strategic planning, target setting, operational planning, financial planning, reporting, and forecasting.

According to research referred to in the pages of this book, forward-looking companies spend significantly more time (44 percent of the total time spent in planning) on forecasting and action-planning activities that can actually improve business performance. They also focus on what is important by implementing best practices throughout the planning process.

You will also find information in the Handbook of Budgeting on the latest business-planning software that allows you to develop budgets quickly by employing Web-based technology to process information over the Internet. Companies that use the latest technology can also quickly assess the impact to their bottom line based on competition, economic slowdowns, and consumer behavior. Always remember that the consequences of inadequate action planning and forecasting can be severe when a company’s performance fails to meet Wall Street expectations.

It is the intention of John Wiley & Sons, Inc., that the Handbook of Budgeting will help you to meet the challenges of this new frontier.

William Rea Lalli, EditorJanuary 2012

Part One

Introduction to the Budgeting Process

Chapter 1 Integrating the Balanced Scorecard for Improved Planning and Performance Management

Chapter 2 Strategic Balanced Scorecard–Based Budgeting and Performance Management

Chapter 3 Budgeting and the Strategic Planning Process

Chapter 4 Budgeting and Forecasting: Process or Process Overhaul?

Chapter 5 The Budget: An Integral Element of Internal Control

Chapter 6 The Relationship between Strategic Planning and the Budgeting Process

Chapter 7 The Essentials of Business Valuation

Chapter 8 Moving Beyond Budgeting: Integrating Continuous Planning and Adaptive Control

Chapter 9 Moving Beyond Budgeting: An Update

CHAPTER ONE

Integrating the Balanced Scorecard for Improved Planning and Performance Management

Antosh G. Nirmul

Balanced Scorecard Collaborative, Inc.

OVERVIEW

The balanced scorecard is a management tool developed by Drs. Robert Kaplan and David Norton in the early 1990s. Since that time, the scorecard has become a standard management practice adopted by large and small organizations throughout the world. The balanced scorecard is based on the simple premise that people and organizations respond and perform based on what is measured. Often this is described as “People respond to what is inspected, not expected.” Measurement becomes a language that communicates clear priorities to the organization.

Because the primary goal of any organization (commercial, governmental, or nonprofit) is to create value for its stakeholders and because the strategy is the way the organization intends to create value, the measurement system should be closely linked to the strategy. The balanced scorecard provides a measurement system that translates the strategy into operational terms through a series of causal relationships defined around four key perspectives (see Exhibit 1.1):

Exhibit 1.1 Four Perspectives of the Balanced Scorecard

1. Financial perspective. For commercial organizations, the financial perspective defines the value created for the shareholders. For noncommercial organizations, the expectations of the financial stakeholders are defined.

2. Customer perspective. The targeted customers and the value they receive from the organization are defined in the customer perspective. The value expectations of the customers typically are developed around the standard attributes of cost, quality, service, and time.

3. Internal perspective. The key processes at which the organization must excel are defined in the internal perspective. Often these processes are grouped into a few key themes, such as operation excellence, customer intimacy, and innovation.

4. Learning and growth perspective. The key capabilities of the organization in terms of people, skills, technology, and culture are defined in the learning and growth perspective. These organizational attributes are the foundation for future strategic success.

By specifying and measuring the organization’s key priorities within these four perspectives, a balanced view can be obtained. One element of this balance is the traditional mix of financial and nonfinancial factors, but the other, more innovative balance, is in the timing of strategic impact. In terms of fostering long-term sustainable success, each of the four perspectives has a time-specific impact that contributes to the concept of balanced management. Even though the overall goal may be financial or shareholder value, each of the other perspectives contributes differently to the outlook for that goal.

The financial perspective measures financial performance for a past period (last quarter, last year, etc.). The customer perspective measures the value delivered to and the overall satisfaction of customers which will have a short-term future impact on the financial performance. The internal perspective measures the ability of the organization to execute its processes that will have a short-term future impact on customer value and a medium-term impact on financial performance. The learning and growth perspective measures the development of organizational capabilities that will have a short-term impact on operational execution, a medium-term impact on customer satisfaction, and a long-term impact on financial performance.

By analyzing and measuring the strategy across all four perspectives, organizations achieve balance between the leading and lagging indicators of performance as well as between financial and nonfinancial factors. The combination of these multiple dimensions of balance allows a more holistic understanding of the organization’s strategic execution and ultimate strategic success. Management should be able to use the scorecard results to obtain a snapshot of the current performance and a forecast of future strategic performance for the organization. This snapshot should highlight any key issues and be a valuable tool in steering the business through the allocation of resources and prioritization of strategic initiatives.

ELEMENTS OF A BALANCED SCORECARD

The primary elements of a balanced scorecard are the strategic objectives, performance measures, execution targets, and strategic initiatives (see Exhibit 1.2). These elements must be clearly defined and properly aligned among the four perspectives to create a useful management tool. Once these elements are aligned, their combination should be able to tell the story of the strategy in a clear and common framework. A well-defined framework will become a standard strategic language that can be used throughout the organization to better understand and manage strategy.

Exhibit 1.2 Primary Elements of the Balanced Scorecard

Strategic Objectives

The strategic objectives are short statements of the strategy that are used to highlight the key priorities of the organization. Specifying the objectives is the first and most strategically important step in designing a balanced scorecard. The objectives should be designed to reflect a midterm version of the strategy, typically the priorities over the next five years. The strategic objectives should highlight the most important priorities for the organization to focus on during this time period. These objectives typically are formatted in a verb-adjective-noun format similar to activities (see Exhibit 1.3 for examples). To show the emphasis on the customer’s expectations, objectives for the customer perspective generally are specified in the words of the customer. The formatting of customer objectives is represented as the key attributes of the organization’s products and services that represent value to the customer.

Exhibit 1.3 Sample Strategic Objectives

The definition of the strategic objectives is an area that clearly makes the balanced scorecard a strategic management tool rather than a simple key performance measure framework. The identification of the priorities of the organization across each perspective requires a well-developed strategy that is understood by the organization. Senior management involvement is especially critical during the definition of the objectives. To define strategic objectives, an organization must understand these questions:

Financial. What is the primary financial outcome for the organization? What are the key financial levers necessary to achieve that outcome?Customer. Who are my primary customers or customer groups? What attributes differentiate my products or services to these customers? What is most important to the customer?Internal. What areas of my internal processes must excel to satisfy the customers? How do these processes link together to meet specific customer needs? What is the internal focus of my organization: operational excellence, innovation, customer knowledge, and other key goals?Learning and growth. What skills and capabilities are necessary to execute the strategy in the future? What type of people and culture will enable the organization’s success? How should we manage technology and information to leverage these assets for tangible results?

Only after the organization has clearly articulated its strategy through the strategic objectives can the subject of performance measures be properly addressed. A large organization can typically expect to define between 20 and 25 strategic objectives for a clearly articulated strategy. More than 25 objectives would indicate a lack of clear priorities for the organization. Fewer objectives can be sufficient if they are defined specifically enough to communicate the strategy effectively.

The definition of the strategic objectives should highlight areas of inconsistency in the strategy. An organization cannot seek to be all things to all customers. The strategic objective process is designed to highlight the most important outcomes that define value for the shareholders and customers as well as the few key processes and organizational attributes that contribute most to that value. The objectives will not cover every activity performed by the organization but should highlight those that will be most critical over the strategic horizon.

Performance Measures

As a measurement framework, the balanced scorecard often is judged by the quality of the performance measures. Performance measures serve to further clarify the priorities of an organization by directly identifying the most important priorities for strategic execution. The performance measures identify how the organization will judge success. Most organizations already have some type of indicators defined throughout the various levels of the business. The issue in defining the scorecard is to identify the most important measures that will reflect the execution of the strategy.

The performance measures on a balanced scorecard often are compared to the dashboard on an automobile. While the driver of the car looks at only a few key metrics (speed, fuel level, etc.), the car itself monitors hundreds of other pieces of information. In our case, the executives of the organization use the scorecard as the key performance information they need to monitor and steer the business while other more operational metrics are looked at within the business. The other operational metrics can be brought forward to the executives only when there is an unusual problem. Major changes (intended or not) in performance and execution should be visible through the scorecard measures.

A number of different types of performance measures can be used on a balanced scorecard (see Exhibit 1.4). The choice of specific performance measures is a very individual decision for the organization. There is no template set of scorecard measures that will be appropriate for any strategy. There are, however, a few guidelines that can assist an organization in choosing appropriate measures:

Exhibit 1.4 Types of Performance Measures

Choose at least one measure for each strategic objective. Total measures should be around 25 for a large organization.Choose quantitative rather than subjective measures where possible.

The goal of these guidelines is to create the most useful set of measures possible. The existence of any strategic objective that cannot be described by a measure should call into question the validity of that strategy. Experience with senior management has shown that using more than 25 indicators makes it very difficult for executives to understand and focus on the results. The clearest measures are those that result in a specific and understandable number (e.g., dollars, number of employees, etc.). Generally, more subjective measures, such as indices and survey results, are more difficult to measure, communicate, and understand. While it is impossible to create a scorecard with only objective measures, the balance should be toward more numerical and less subjective indicators.

Another key factor to consider when choosing measures is the frequency of data reporting. The organization cannot expect to have executive discussions on scorecard results each quarter if its data are available only on an annual basis. The choice of measures should correspond to the frequency of desired reporting. Most organizations review their scorecard performance and strategic focus on a quarterly basis. In this case, at least 75 percent of an organization’s scorecard measures should be available at that frequency.

Execution Targets

The setting and communication of targets are key steps necessary to operationalize a scorecard. While the measures communicate where management focus will be, the targets communicate the expected level of performance. For example, a measure such as customer retention shows a strategic focus: The difference between a 90 percent target and a 60 percent target represents a major shift in strategy. The setting of appropriate targets can be a difficult and painful process.

An important distinction in setting targets is the difference between standard performance targets and “stretch” targets. Stretch targets typically are used in areas of new or enhanced strategic focus and are meant to move the organization in new directions. Typically these targets are multiyear in nature, and their implementation approach is not fully defined when they are initially set. For an established organization, a target such as doubling revenue in three years would require significant changes. Often the precise steps needed to reach that target are not yet defined. The use of a stretch target forces innovation and change in an organization.

Obviously, an organization cannot set 25 stretch targets and hope to achieve all of them. Most execution targets will be more traditional incremental advances that reflect successful execution of the strategy. The choice of where to use stretch versus incremental targets strongly defines the emphasis in the strategy. Stretch targets create inspirational goals for the organization; incremental targets supplement those goals with core areas that need continual focus for sustained success.

The key point in choosing appropriate execution targets, whether stretch or incremental, is evaluating the capabilities of an organization and its resources. Incremental targets should be clearly reachable given the available resources and capabilities. The setting of unreasonable targets undermines employee faith and accountability in the performance management process. While the achievement of stretch targets may not be easily envisioned initially, the targets should come into clearer focus as the time period for the stretch goals is crossed. Every stretch target should have a measurable time period attached and should be updated throughout that time frame. Typically, stretch targets would be set at a maximum of 20 percent of the total measures and with 80 percent of targets remaining as incremental improvements.

Strategic Initiatives

Strategic initiatives are actions or projects that represent the primary path through which organizations create new skills, capabilities, or infrastructure to achieve strategic goals. In this definition, strategic initiatives are different from projects or actions that simply create incremental improvement over or maintain the existing skills, capabilities, or infrastructure of an organization. For example, in a financial organization, a project to build a new online ability to process self-service customer transactions could be a strategic initiative while a project to improve the interface of existing online tools or extend the online services would be considered an incremental upgrade of existing capabilities.

The criteria that an organization uses to define which actions are considered strategic versus basic projects are unique to its strategy and circumstances. Typically, a strategic initiative has a certain strategic importance, size, and breadth of influence that makes it more than an operational project (see Exhibit 1.5). The goal in identifying actions that are strategic initiatives versus operational projects or activities is to be able to allocate resources in a more strategic manner using the scorecard and strategy. This distinction is explored further in the separation of operational versus strategic budgets when the scorecard is integrated into the planning process.

Exhibit 1.5 Key Criteria that Separate Strategic Initiatives

When creating a balanced scorecard, an organization should be able to identify its existing strategic initiatives and map them across the strategic objectives and measures on the scorecard. The mapping process is particularly important in that it can identify areas of strategic alignment (see Exhibit 1.6). Any identified initiative that cannot be mapped directly to a scorecard objective may not truly be a priority effort for executing the current strategy. Conversely, a key strategy with stretch targets that does not have an initiative associated with the strategy will be difficult to achieve (the target). Initiatives are particularly important for instances where stretch targets are defined, which by definition requires the development of new organization abilities.

Exhibit 1.6 Sample Initiative Mapping

In Exhibit 1.6 you can see certain gaps where there are no identified initiatives for the specified objectives. These gaps need to be carefully analyzed based on their context before any decisions are made. Financial objectives typically do not have many initiatives attached to them because as ultimate outcomes all initiatives eventually support the financial goals. Most initiatives will directly support the internal and learning and growth perspectives that represent the strategic processes being implemented to achieve the customer and financial outcomes. The lack of an initiative for a specific objective may mean that the organization can achieve that goal with incremental effort or that there is a strategic gap. In performing this analysis, the relation of the overall execution targets to the organization’s current capabilities is particularly important. While initiative mapping often helps an organization to eliminate unaligned activities, it should not become an exercise in creating initiatives simply to fill gaps in a mapping diagram.

USE OF STRATEGY MAPS

As the use of balanced scorecards has increased, organizations have found value in a number of processes that expand on the original concepts. The strategy map is one of these additional value-added concepts that helps to organize the strategic objectives into a logical cause-and-effect chain. At its simplest, a strategy map is a diagram that organizes the strategic objectives visually into the four perspectives and attempts to show linkages between them with a series of arrows. Exhibit 1.7 offers one example; there is an almost infinite number of ways to display these objectives and linkages graphically.

Regardless of the graphical choices, the strategy map is designed for one key function: to tell the story of the strategy. The cause-and-effect linkages should explain how your organization will attempt to take intangible assets, such as knowledge and information (found in the learning and growth perspective), and turn them into tangible outcomes, such as customer satisfaction and shareholder value (found in the customer and financial perspectives). The key translators in this case are the core organizational processes found in the internal perspective.

If you examine the left side of the strategy map in Exhibit 1.7, you can read one part of the strategic story for this organization. By building the right skills, particularly customer-focused skills, the organization will be better able to understand the needs of its customers. This understanding will help it more effectively market its products and services to the target audiences, which should result in stronger and deeper customer relationships. The combination of better marketing and broader relationships will help it to be viewed by its target customers as a complete provider of solutions. By broadening relationships with existing customers and reaching target customers more effectively, revenue growth and ultimately shareholder value can be achieved.

Exhibit 1.7 Sample Strategy Map from a Fictional Utility Company

The fact that strategy maps can be used to explain the effect of intangible assets on overall results makes them useful communications tools. Organizations use such maps to help individuals understand their role in executing the strategy. It is much easier for human resource managers to understand that their efforts to build an organization’s skills and climate result in better relationships with the customer than to try to understand how those efforts directly influence revenue growth or shareholder value. The key to mobilizing an organization around a strategy is having individuals understand how they can impact strategic success. The strategy map is an important tool that, when combined with the scorecard, allows employees to understand and focus on the key priorities to achieve the vision.

SCORECARD CASCADING

Just as the strategy is clearly articulated through the four perspectives for the overall organization, it should be done in a similar manner for each of the operating and support groups. The cascade process creates aligned scorecards at multiple levels of the organization to focus resources and attention on the key strategic priorities. There are typically a number of key themes where focus is needed throughout the organization for sustained success. In a utility organization, this might be reliability; for a manufacturing organization, it could be quality; a service organization may have customer relationships; and so on. For any of these core themes, each subsidiary organization must contribute, whether it is marketing, production, or information technology. The scorecard helps to create better strategic alignment among the units toward achieving the organization’s goals.

Ideally, the overall corporate scorecard will be developed first to articulate the core themes. Given the strategic priorities for the overall organization, each subsidiary group can analyze its own strategic destination and approach. The actual maps and scorecards may look different based on the organization’s strategy at each group’s own level. Most market-facing operating units will be focused toward a specific subset of the overall organization’s customer base and product portfolio. These groups should develop a customer perspective aligned to their specific market focus.

Independent elements of the value chain (assembly, distribution, etc.) or shared service units (information technology, human resources, etc.) will designate internal customers for their key outcomes. The customer perspective in this case must identify the key needs of the internal customers and the relationships the internal customers desire. The financial perspectives for the internal-facing units typically are focused on process efficiency and effectiveness. They must deliver a specific type of value to the market-facing organizations to drive overall shareholder value. An example of this is shown for a supply chain organization in Exhibit 1.8. Here you can see how a map for an internal-facing organization has a very different internal and customer focus from one for the overall organization.

Typically, an organization will designate a few key strategic objectives and measures that every part of the organization must use. These shared objectives often include the overall shareholder value measurement, a focus on employee satisfaction or development, a consistent risk management process, and so on. These shared objectives are the initial building blocks for the cascaded scorecards. The remainder of the scorecard will be based on the units’ unique and aligned strategy. In Exhibit 1.8, a few key objectives, such as F1, have been mandated throughout the organization. Other objectives, such as L1, have been taken and interpreted for the specific organization.

Exhibit 1.8 Sample Strategy Map for a Supply Chain Organization

Much has been written on the right number of scorecards for an organization. There is no magic number. As you develop past two or three levels, the scorecards begin to become smaller and more focused. Some organizations have cascaded down to personal scorecards for individuals that combine the key shared metrics of the organization with specific goals for the person, his or her team, and business unit. While organizations have derived great value from the cascading of scorecards to individuals, it is recommended that an initial implementation of the balanced scorecard focus on the first two to three levels of an organization. Further cascading should take place in subsequent management cycles and leverage the learning from the initial implementation.

BRINGING IT ALL TOGETHER

As discussed, the balanced scorecard is designed to create management focus on the strategy by translating that strategy into operational terms through the use of strategic objectives, measures, targets, and initiatives. The implementation of a good balanced scorecard requires a number of elements:

Leadership involvement. The scorecard is designed around the strategy, and senior leadership must commit to articulating and communicating the strategy through the framework. They must unfreeze the organization to implement effective change in the management process.Cause-and-effect relationships. Each element of the scorecard must be linked to the key outcomes through a clear cause-and-effect chain. The lack of these relationships typically identifies gaps in the strategy.Performance measures. There must be a complete and balanced set of outcome and driver measures that can report data necessary to steer the organization. A lack of key measures or the data to support them will invalidate the value of the scorecard.Stakeholder value. The value to the stakeholders (shareholders, customers, employees, etc.) must be clearly articulated. The cause-and-effect chains should lead directly to the creation of value for these groups.Initiatives that create change. The portfolio of strategic initiatives must be defined to move the organization toward the strategic destination. A lack of initiatives may impede strategic success while too many can reduce focus and overstretch resources.

An effective scorecard must have all of these elements and be clearly linked to the other management processes within the organization. The rest of this discussion focuses on the linkages of the scorecard with the strategic planning and budgeting process as well as the use of the scorecard as a continuous management tool. Without continued focus and attention on the strategy, an organization cannot reach its goals.

INTEGRATING THE SCORECARD WITH PLANNING AND PERFORMANCE

A successful balanced scorecard process is one that does not exist on its own but is seamlessly integrated with the overall planning and performance management processes of the organization. The scorecard brings value to the integrated processes by providing a focus on strategy with a common language and organizing framework. Many organizations have used the balanced scorecard as a way to streamline and standardize their management processes. The ability of the scorecard to leverage its common elements and lexicon at the corporate, business group, division, or even individual level provides an ability to synchronize and align previously disparate processes.

The integration of the balanced scorecard with planning and performance processes must happen in two key ways:

1. Annual planning process. The balanced scorecard represents a significant improvement in the ability to link the periodic strategic planning process with the budgeting process.

2. Ongoing strategic management. The balanced scorecard allows the organization to review its performance based on the successful execution of the strategy as well as traditional financial and budgetary concerns. Better information allows the organization to make strategic decisions faster and with better results.

The value the scorecard brings in putting strategy at the forefront of measurement and performance is achieved only through continuous focus. Successful organizations have used the balanced scorecard as a key tool in communicating the strategic priorities of the organization during the annual planning process as well as a measurement tool for assessing ongoing execution success.

BALANCED SCORECARD AND ANNUAL PLANNING

For most organizations, integrating the balanced scorecard with their annual planning process represents a way to streamline and align existing processes rather than develop and implement a totally new process. The scorecard can add value to almost any type of planning cycle. For purposes of this discussion, we focus on a traditional annual budgeting process.

Exhibit 1.9 shows where the scorecard process fits in the planning cycle (primarily as the link between strategic planning and the budgeting process). We also see that the scorecard can have a profound influence on the budgeting process and should influence the priorities of the strategic planning process.

Exhibit 1.9 Key Steps in an Integrated Scorecard Planning Process

Integration with Strategic Planning

The widespread use of scenario planning techniques has helped to standardize and improve the effectiveness of strategic planning processes. The scenario plan should identify the key factors in the marketplace and regulatory environment that will impact the organization’s strategy. In terms of integration with the scorecard, the scenario plans should include a major focus on the targeted customer groups. To properly define the strategy and strategic objectives, the shifting needs and expectations of the target customers must be forecasted accurately. Additionally, the competitive landscape for these target customers must be examined closely to determine if the differentiating factors for the organization will still be relevant in future periods.

Understanding future customer and market conditions through the scenario plans will also have a major impact on the internal process priorities. In situations in which the competitive advantage of an organization is forecast to decline, a new focus on customer acquisition or product development activities is likely to be necessary. Obviously any change to the operational focus will also require corresponding changes in the organization and its skills and culture.

The outcome of the scenario planning process should be a primary scenario that details the key market and environmental conditions for the planning horizon of the strategic plan. Alternative scenarios should also be retained to allow contingency plans to be integrated with the overall strategic plan. The executives should be able to understand and discuss these scenarios to develop the final overall strategic plan.

The resulting strategic plan should focus on two key points:

1. Strategic destination. The destination identifies the primary goals for the organization over the plan horizon. This destination may be expressed in financial terms, market position, and/or desired customer relationships.

2. Strategic approach. The approach should focus on identifying the key priorities and milestones along the path to the destination.

The destination must be stated in a way that communicates the guiding principles behind strategic decisions and may have multiple components. For example, a company may wish to achieve the largest market share while leading its industry in employee satisfaction ratings. While the destination always should be a large and ideally inspiring goal for the organization, it should not be contradictory or seem impossible. For example, an organization is unlikely to be the lowest-cost provider while achieving the highest customer satisfaction. The clarity of the strategic destination is the key to enabling effective strategic management.

The approach should specify the available resources that will be deployed to reach the destination. The available resources must be aligned with the destination to communicate a reachable but inspiring goal for the organization. The approach should be specific in terms of organizational changes that need to occur and include reorganizations, skill transitions, or acquisition/divestiture intent. The approach must be precise enough to allow for proper resource alignment and strategic focus.

The combination of a clearly articulated strategic destination and approach will allow the organization to effectively measure progress and steer the organization toward the destination through the strategic management process driven by the scorecard.

Update Objectives and Measures

Once a clear strategic plan has been identified, the scorecard elements must be updated to reflect any changes. The financial and customer perspectives must be aligned to the strategic destination. The financial perspective will state the overall financial destination and the key financial levers that will enable value creation. For example, an organization that is moving toward a cost-leadership strategy may need to put more emphasis on the cost and asset utilization objectives rather than revenue growth. The customer perspective should identify the target customer groups and the key value that those groups will expect. For this example, the organization should have customer objectives focused on cost, consistency, and efficient service.

The internal and learning and growth perspectives will typically be focused on articulating the strategic approach. The primary internal process focus areas should be identified in strategic themes that collect related objectives. Continuing the example, an operational excellence theme might contain objectives focused on machine reliability (to drive asset utilization), supply chain efficiency (to drive cost leadership and cycle time), and safety. The learning and growth perspective should articulate the changes in skills (through development or acquisition), culture (through training or accountability processes), and information (through systems or process changes). In this example, the organization may need to increase its skills in process management, move accountability closer to the operational decision makers, and improve its ability to analyze operational performance for continuous improvement.

As the objectives in each perspective are adjusted, the measures must change as well. In general, any change in the objective will require a change in the measure. Measures should also be evaluated for objectives that have not changed. The key factor in the evaluation of existing measures should be the quality of information that was provided by the measure and the resulting ability to make decisions based on that information. In many cases, the organization may change the frequency of collection or the underlying calculation of the measure to improve information quality.

Traditionally, organizations tried not to change their performance measures in order to gain long-term trending and comparability information. The balanced scorecard does not dispute that goal but seeks only to ensure proper alignment between the strategy and measures by updating them together. Because the scorecard objectives and measures are designed to highlight the most important priorities, successful organizations will find that they have reached their goals and no longer need to retain certain measures over time. For our example, once supply chain efficiency has been moved to a sustainable goal, the focus may shift to product development cycle time.

The adjustment of the strategic objectives and measures must be first carried out for the overall corporate scorecard and then cascaded down to the operating and support units. As discussed in the cascading section, common objectives and measures should be used where strategic themes cross organizational boundaries. These common strategies should be a key focus for the final alignment of the cascaded objectives and measures.

Develop Corporate and Business Unit Targets

The use of the balanced scorecard to communicate key targets before the primary budgeting phase delivers significant value to organizations with integrated processes. In a traditional planning process, the operational units begin a bottom-up budgeting process based on their prior year’s performance. Because this process typically begins before the communication of new strategies and resource commitments, it results in misalignment with top management priorities and multiple corrective iterations that add time and frustration to the process. The use of scorecard targets to provide direct input into the budgeting process of operating units can help eliminate this frustration and reduce time spent in iterations by aligning the expectations of senior management with those of the operating units.

At the conclusion of the strategic planning process, the organization should be able to clearly articulate the targeted customers and the mix of products and services that will be provided to them. The strategic destination and approach should be formalized by setting the primary scorecard targets in the financial and customer perspectives for the overall corporation. The financial targets should communicate expectations for overall shareholder value broken down into revenue, expense, and capital allocation components. The customer targets will articulate the market share, customer segmentation, and product portfolio expectations.

There should not be an expectation that all scorecard targets will be known before the more detailed operational plans and budgets are created. The strategic planning process should easily be able to set the financial and customer targets based on the overall strategic destination. The strategic approach should also be able to specify at least some of the key internal and learning and growth targets at the corporate level. The primary goal should be to cascade the financial and customer targets to the level of the key operating and business units. The scorecards for the operating units will then be updated with the overall strategic destination and performance expectations for the corporation.

While the core strategy for the organization is set at the corporate level, the actual execution of that strategy happens within the operational units. Even though the overall strategic approach will have set out some key focus areas, the business units will develop their detailed approach to implementing the strategy during their operational and strategic planning, processes that will allow them to set their final targets in the internal and learning areas of the scorecard.

The value in setting the corporate and business unit targets for the financial and customer dimensions is achieved by communicating them early enough and at a sufficient level of detail to align the detailed business unit planning before that process is under way. In many organizations, the time spent by in reconciling the detailed budgets of the operating units with the financial expectations of the corporations at the end of the planning process is essentially wasted effort. By better aligning the expectations at the beginning of the process and aligning the planning schedules of the operational units to wait for the strategic targets, the overall planning effort is reduced and the overall satisfaction with this effort is increased at both management and executive levels.

Develop Business Plans

Once the strategic planning process has concluded with the strategic destination and approach specified and translated into key financial and customer targets, the operational and support units should create their detailed business plans that will articulate their specific approach to deploying their assets and resources to meet the strategic goals. Much has been written on the level of detail that these plans need to encompass. The clearest guidance is that the business plans for each unit should be as short and as streamlined as possible while providing sufficient management information for the organization.

The basic business planning methodology includes an articulation of the strategy and the budget for each of the participating units. In integrating the scorecard, the strategy components of the business plan should be easily cascaded from the corporate strategic plan using the predefined strategic targets. The important strategy components for the operating units are no different from those at the corporate level, mainly the key financial goals, targeted customers, product portfolios, and organizational approach to meet those goals. The focus of this discussion is on the budgeting elements of the business plans.

In implementing strategic management processes and aligning them to budgeting, the key learning is that the budgeting process must be split into an operational budget, which is directly influenced by the strategic targets, and a strategic budget, which becomes an integral part of the strategic management process. The split between these key elements is illustrated in Exhibit 1.10. This split is very different from a traditional alignment based on capital versus operational expenses and is discussed further in the sections on operational and strategic budgeting.

Exhibit 1.10 Split between Operational and Strategic Budgets

Aligning the Operational Budget

The operational budget is made up of a number of line items that can be representative of both capitalized and expensed items. In working with utility companies, they refer to this budget as what is necessary to keep the lights on. Basically, the operational budget refers to those activities that are ongoing and necessary to maintain the current capabilities of the organization to produce, sell, and service its core products and services provided to the customer base. The operational activities may include marketing, customer service, operations, overhead, support, maintenance, and so forth. The primary difference between this and the strategic budget is that strategic line items are discretionary in nature and designed to build new capabilities that are beyond the core customers, products, and operations of the existing organization.

The operational budget by far makes up the major component of the expenditures of most organizations. Most operational budgets comprise up to 90% of the total expenditures for the organization. The approach to developing this budget is no different from that discussed in other best-practice budgeting approaches. Ideally, the budget should be defined in a top-down manner using activity-based budgeting techniques that result in the minimum number of line items for effective management.

The only key difference in this process for scorecard organizations is the use of the targets. The problem most organizations have in implementing activity-based budgeting is the need to know precisely what products and services will be provided to what customers at what levels of service. The previously discussed target setting based on the strategic plan should focus on providing exactly this information. Once an organization’s core activity performance is understood, the creation of the specific line items should be more of a systematic journey from the targets rather than an incremental update from prior-year performance (i.e., last year plus 10 percent, etc.).

The delivery of clear outcome targets from the strategy should allow the operating units to better understand the resources they will require to implement the strategy. The inclusion of the resource constraints of the organization with the outcome targets allows the budgeting process to be done with the confidence that these resources needs will be approved and implemented. The confidence given by early targets greatly improves both the accuracy of the process and the organizational commitment to using it as a key business tool.

Aligning the Strategic Budget

While the strategic budget often represents only 10 percent of an organization’s total expenditures, it is the key means to implementing new strategies and transforming the organization for future success. The management of a separate strategic budget differently from the operational budget components is new to most organizations. The linkage to a scorecard-based strategic management system is clear because the strategic budget is composed of the key strategic initiatives for the organization.