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Executive Summary

Budgeting is an important management control system in many organizations.(1) Its main goals are to facilitate operational planning, resource allocation, performance evaluation, strategy formation, communication, and benchmarking.(2) However, budgeting can be a frustrating management process. The traditional budgeting process is broadly seen as having many flaws or limitations, the chief ones being that it:

• Is too time consuming,
• Requires too many iterations,
• Can be very costly,
• Does not address capacity,
• Is based on an extrapolation of prior period data,
• Is influenced by political gaming, and
• Receives limited buy-in or acceptance of results.

The Activity-Based Planning and Budgeting (ABPB) Interest Group of the Consortium for Advanced Manufacturing – International (CAM-I) was formed to investigate how to improve planning and budgeting by incorporating activity-based concepts. This book contains the Group’s recommended approach:

• The CAM-I ABPB Closed-Loop Model, (referred to as “the Closed-Loop Model”), a new approach to calculating the activity, resource, and financial requirements of an organization and its units, (3)
• The CAM-I ABPB Process, which contains the business processes and techniques needed to support the Closed-Loop Model, and
• The CAM-I ABPB Implementation Program, a structured approach to introducing the Closed-Loop Model and ABPB Process into an organization.

The three parts of this book build on each other, starting with the development and application of the Closed-Loop Model, then its implementation and sustainment, and finally the linkage of the Closed-Loop Model with traditional approaches and other strategic initiatives.

The heart of the recommended approach is a budget calculation engine, the ABPB Closed-Loop Model, which is summarized in Figure 1. The Closed-Loop Model has three important features.

• It is activity based,
• It explicitly matches resource demand and resource capacity, and
• It achieves operational balance and then confirms financial balance.

The detailed calculations involved in the Closed-Loop Model are shown in Figure 2. The Closed-Loop Model is based on an integrated view of the organization and solves many of the problems of most traditional budgeting approaches. The Closed-Loop Model explicitly links resource capacity with resource demand and avoids building a budget based solely on extrapolation of prior data. Because the Closed-Loop Model is based on an observable model, there is less room for disagreement on many of the operating and financial factors, thus reducing political gaming. When staff and management can observe the relationship between inputs and outputs, they are more likely to buy into the budgeting process. Finally, because the Closed-Loop Model is rooted in the actual operating and financial performance of the organization, budget iterations will cost less, will be more meaningful, and will be fewer in number (if management does not use the improved planning features to run more scenarios).

This book contains many examples of applications of the Closed-Loop Model in a variety of industries. For competitive and confidentiality reasons, none of the organizations have been named, although the concepts and lessons learned are incorporated throughout.

While this book is intended for managers and executives with responsibilities for organizational budgets, we firmly expect that managers in operating functions will find the Closed-Loop Model as useful as those in financial functions.

But why read this book? After all, in today’s literature, one finds strong advocates of simply eliminating the periodic budgeting process and the detailed budget which results. We do not believe that such a solution is either viable or practical for the overwhelming majority of organizations, and therefore the budget is likely here to stay.

The Closed-Loop Model reflects a powerful new budgeting approach that speaks to many of the problems associated with traditional budgets and budget processes while retaining and enhancing the benefits obtained from the process. At a minimum, the Closed-Loop Model can supply an improved calculation engine for, and extend the operational relevance of, a traditional budget process. However, an organization will only obtain the full benefit of using the Closed-Loop Model by restructuring the performance evaluation system so that the operating and financial metrics are in harmony with those used for performance measurement. Following that path will also support an organization as it strives to improve the integrity and accuracy of its financial planning and budgeting processes, an integral component in performance measurement and reporting.

This book provides guidance for achieving the maximum benefit from the budget process.

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Footnotes

1. Simons, R. 1995. Levers of Control: How Managers Use Innovative Control Systems to Drive Strategic Renewal. Boston, MA: HBS Press.

2. Hansen, S., and W. A. Van der Stede. 2002. Six Facets of Budgeting: Antecedents and Performance. Working Paper, University of Southern California.

3. Throughout this book, the term “organization” refers to the highest level of a corporation or agency, such as the parent company. The term “unit” refers to any group in the organization, such as a subsidiary, branch, division, or department.