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From Budgets to Budgeting

By George Watts – former accountant at Humberside TEC

In the good old days when I was a trainee accountant, the budgeting cycle was so simple. It would start in May each year when we would draw up our 5 year business plan and the first year of this 5 year plan formed the basis of our budget. In October and November we would then start to draw together our detailed business plan and budgets for the coming year, working on this through Christmas, finally reaching agreement with Head Office just in time for the new financial year in April. What was the value of this?

Well we had a plan of action for the coming year, budgets were agreed, accountable managers were ready to be accountable, and I was ready to explain variances of all kinds because from day 1, the world had moved on and we were working on an expected plan, devised in May the previous year that was already 11 months out of date.

So each month we produced management accounts, we explained variances and produced forecasts, but the budget remained the same and we were held to account against it come what may. In reality, the system wasn’t simple and created a great deal of unnecessary work.

In 1993 I joined Humberside TEC with no knowledge at all of their business planning and operational procedures, but if I thought I’d worked in an environment of change before, then I still had a few lessons to learn.

This was the early days of the TEC, financial procedures were in place but they were basic. Budgets were delegated to managers throughout the organisation and conversations could regularly be heard which contained the following type of comments,

“I’ve got a bit of spare money in my budget for that”

“We need to do it, but whose budget is that going to come out of because I’m fully committed on mine”

“We put a bit of extra money in the budget just in case”

Budgets were regarded as personal pots of money, owned by the accountable manager to do with as they wished and guarded with more fervour than the Crown Jewels.

So what was wrong with this? Don’t we want local accountable managers taking decisions in a dynamic changing environment? Of course we do, but we also want to ensure that financial resources are being put to best use to meet the aims and objectives of the organisation. In one year (and this year was not atypical), the budget was agreed in January for the following financial year with a deficit of £2.5 million. The TEC Board reluctantly agreed to the deficit, especially as the Executive Team informed them

“It won’t turn out like that in 12 months time”

We were asked

“Why set such a budget when you know it won’t be like that?”

To which the Executive Team replied

“Because that’s the total the managers say they need to do everything they need to do this year. Under the current management accounting procedures that is how we produce the accounts as we don’t know where the underspends will be”

So how did this year actually fare? Well from period 1 the TEC made a surplus, reserves grew but each period throughout the year revised expenditure forecasts were obtained from budget managers, aggregated and the total showed a significant forecast deficit. The TEC was unable to react to changes in circumstances and exploit opportunities afforded by the market place because of these forecasts until it was too late. The end of year position? Well the Executive Team were correct in their assessment of how the year would turn out as a surplus of £800,000 was achieved, some £3.3 million better than had been planned and all of this was accounted for by the expenditure underspend.

From an organisational perspective, this meant that the organisation had planned to take a course of action, budgeted accordingly and then throughout the year managers had produced forecasts which said they were following this course of action when in fact they were no where near? Imagine sailing a ship with the same directional forecasting mechanisms

Action was required to address this situation, and so we introduced a system of “dynamic budgetary control”.

All staff were afforded a half day training programme about the new system to be introduced which was based on the following principles

  • Budgets are not pots of money : they are a financial representation of a plan of action
  • Any plan of action followed by a manager must be undertaken to deliver the aims of the organisation
  • The organisation is in a dynamic environment, and so plans will require regular revision as will the associated finances (the budgets)
  • Planning is a continuous process

So how did this work in practice? The planning process remained unchanged, with business planning being undertaken from November onwards and budgets being agreed prior to the start of the financial year. However, budgets were now clearly recognised as being a financial representation of a plan of action, and this plan of action was regularly reviewed in the light of ever changing circumstances. The original budget is now not seen as a financial plan cast in concrete. It is a financial representation of the plan we expect to follow over the coming 12 months, but this will definitely change as the year progresses.

So if the plan and budget aren’t fixed, how do we ensure we the organisation delivers its objectives? Quite simply, instead of budgetary control we introduced a system of forecast control. What this means is that the environment in which the TEC operated was constantly reviewed and the plans of the organisation were adapted to deliver the new requirements. Plans of action were therefore reviewed and financial forecasts were drawn up to fund these plans. These forecasts became the new budget, and so we no longer had the issue of budgets being pots of money with surpluses being built in “just in case”, as on a regular basis plans were reviewed, revised and funds reallocated according to need. Therefore, if an activity was deemed essential to deliver the plan, funding was made available.

What were the results of this change in financial management

  • Planning and associated financial forecasting was dynamic
  • Budgets although set were regularly reviewed and revised to the latest agreed forecast
  • Management accounting and variance analysis was always against the latest plan which was never more than 3 months old, so avoiding the excuse that “things have changed since we set the plan”
  • Management accounting emphasis was to be proactive and forward looking, the emphasis being placed on forecasts (although an understanding of the past was essential to predicting the future)
  • Planning and associated business forecasting improved
  • Funds were more fluid around the organisation as they were based on the current plan
  • Managers became less precious about their budgets
  • Less time was wasted “playing the system” and instead this was channelled into delivering the business aims and objectives

In effect we removed the responsibility from managers for “budgets” and they became accountable for activity and forecasting (of both numerical and financial outputs). So they no longer had budgets but they still did budgeting. In complexity terms it was said that we changed our focus from things (budgets) and started to concentrate on the flow ensuring that the patterns we were dealing with were the current ones rather than up to a year old.

Of course such cultural changes didn’t happen overnight. Old habits die hard and it takes time and effort to build trust in any new ways of working.

Several years after the introduction of these changes I attended a CIPFA seminar in London with representatives from both the public and private sector discussing new methods of planning and budgetary control. At the end of the day I left and was talking to one of the days organisers whilst waiting for the tube back to Kings Cross. He asked what I thought of these revolutionary new ideas I’d heard throughout the day to which I was honest and replied

“Humberside TEC already operates on that basis”.

He was a little taken aback, but it was pleasing to know that the TEC way of working was being advocated by a major accountancy body and some major players in both the public and private sector. It was more pleasing to know we had developed it all ourselves.

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