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FMI
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IGF JOURNAL
VOLUME 25, NO. 2
an allowance to an uncomfortable level
of 5% prior to project implementation.
Conservatively, the allowance should
remain as high as possible until project
completion. Unexpected requirements
always surface regardless of how
diligent the consultation and planning
process has been; a budget department
should always anticipate the unexpected
and factor in an adequate contingency
allowance. Budget departments should
be up front about the inclusion of
such an allowance and be prepared to
challenge decision makers who may
suggest the amount be reduced.
4)
Lack of time.
Decision makers are always under
pressure to announce innovative
developments before subject experts and
budgeters have had adequate time to
work through the details underpinning
the announcements. Frequently, initial
project announcements significantly
understate the final completion cost.
Decision makers should be encouraged
to either give the costing experts more
time to work through the details or
make their announcements without cost
estimates, acknowledging that the plan is
still at the concept stage. Alternatively,
if costs must be announced, a healthy
contingency allowance must be used.
5)
Innovative design and / or process.
Some projects are announced using
cutting edge technology and the
development process may be novel. A
prime example is the Boeing 787 plane –
the plane’s engineering is innovative and
its high decentralized manufacturing
process is a significant departure from
past methods. The plane’s initial delivery
was delayed by approximately 3 years
and development costs have significantly
exceeded those approved by the Boeing
Board of directors in 2004. It is not my
intent to suggest what may have gone
wrong – business schools will probably
use the 787 development as a case
study in the future – but I would like to
comment on how a budget department
may deal with such innovative change.
First, Boeing deserves full marks for
trail blazing down such an innovative
path. Without such innovators we’d
be still driving the Model T Ford.
Second, such innovation can be a
budgeter’s nightmare – go heavy on the
contingency factor (and I mean heavy
like 300%) and then determine if there
is a business case for such a development
presenting decision makers with a series
of “what if” breakeven volumes. A lot
of anguish will be avoided if realistic
breakeven volumes are known at the
time of project approval.
The budget department exists to
ensure that program decision makers
operate within their means and don’t
beach the enterprise. Executives don’t
want to have to explain what went
wrong. You need to slow your executives
down, alert them to the financial and
delivery risks, encourage input from
program experts, monitor scope creep
and build in adequate contingencies.
Don’t be afraid to alert the decision
makers to pending risks.
INCREMENTAL AND ZERO-
BASED BUDGETING
Budgets are built using either an
Incremental or zero-based approach
. In
reality, a combination of the two methods
are often used.
Incremental Budgeting
Incremental budgeting assumes that
the previous year’s base budget is
accurate with increases in the current
year required for either increased costs,
like compensation agreements or new
programs such as services that were
not funded in the previous base budget.
Building a budget using this method
has advantages and disadvantages,
with the later often dominating. The
major advantages are that costs can
be rapidly estimated without detailed
knowledge
2
of the components within
the existing base budget. However,
disadvantages also exist. For instance,
when the economy is in recession job
opportunities are less, so employees
stay longer in their current positions
gravitating to the top of their pay range.
As a result the average personnel cost
skews higher leaving insufficient funding
to fill vacancies or requiring lay-offs if
vacancies don’t exist. While reducing
the number of personnel may be an
intended management strategy in this
example, it would be unfortunate if this
effect was merely due to the incremental
budgeting approach being used. As the
reader can imagine, the accuracy of an
incrementally built budget deteriorates
as budget changes (either increases or
decreases) are layered on a base budget
year after year.
Zero-based Budgeting
Zero-based budgeting assumes a
starting base budget of nothing. Every
item to be funded must be identified,
justified and the cost estimated. This
method is resource intensive, literally
having to account for every pen and
pencil; however the end result is very
accurate. The method is normally used
when:
➢
a budget for new program is built,
➢
the accuracy of the budget for very
transparent spending is critical, such as
the Senate travel expenses, or
➢
a review of the base budget is needed
to find savings for unfunded higher
priority initiatives.
Ideally a program’s budget should be
reviewed independently and zero-based
periodically.
In reality, most budgets are built using
a combination of the incremental and
zero-based methods, whereby budget
bases are assumed to be accurate and
the additional incremental pieces are
determined using a zero-based method.
Monitoring
Any organization whether private or
public must constantly monitor both
spending and revenue to ensure that
budgeted targets are achieved, and
corrective action taken when deviations
seem probable. While the private sector
is more likely to monitor the bottom
line (revenues less spending), the public
2
This allows central budget departments to
estimate budget increases without having to
disclose increases to affected programs under
consideration.
3
Typical assumptions could include: the timing
of staff attrition and hiring; progress and cost of
contracted services; and, fluctuation in service
delivery requirements.
TACIT KNOWLEDGE
