Can performance budgeting help achieve a company’s goals?
Performance budgeting is a type of budgeting that allows you to measure performance at different levels of an organization. It is a process of identifying the results achieved by each division of the organization. For a proper appraisal of each division’s results, the responsibility of every executive in the organization needs to be defined in terms of results expected from him or her.
Since it fixes the responsibility of all employees working across the organization, performance budgeting is sometimes also considered to be synonymous with responsibility accounting.
What is a performance budget?
A performance budget is looked upon as a budget based on functions, activities, and projects. In each reporting period whether it’s a month, quarter, or year, actuals are compared with performance targets set for a business division, department, or manager. The degree of efficiency and achievement is measured using some pre-defined performance measurement criteria.
Thereafter, funds for the upcoming period are allocated based on the evaluation of the productivity of different operations. The business operations that are contributing the most towards the organizations’ profitability are given maximum attention and consequentially, a larger share of the budget is allocated to those divisions/operations. Thus, performance budgeting is nothing but linking funding and results.
Performance budgeting is characterized by the following:
- A performance budget is prepared for each managerial level (or division). And the manager concerned is made responsible for his performance at his level over a specified length of time and is held accountable for it.
- Each individual is held responsible for only such costs that are controllable by him or which fall in his jurisdiction.
- As the outcome of all divisions or managers is analyzed against their pre-fixed responsibilities (standards), we can say that the ultimate focus of performance budgeting is on the “results”.
Performance budgeting vs. traditional budgeting
Traditional budgeting is not the same as performance budgeting.
Rather than the physical aspects or performance, traditional budgeting lays more emphasis on financial aspects. But unlike traditional budgeting that deals with the things to be spent for or acquired, performance budgeting focuses attention upon the work to be done and the services to be rendered.
Traditional budgets are usually built around varied items of expenditure, be it salaries, stores and materials, rates, rents, and taxes, or more. A fixed amount of money is kept to be used for a particular expense. However, performance budgets are more concerned with establishing a relationship between inputs (i.e., funds) and outputs (i.e., results). And with such a relationship, they appraise the working of organizational functions, programs to discharge those functions, and the activities that will be involved in undertaking those programs. Funds are set aside for those programs that exhibit good results.
Some of the purposes served by performance budgeting are:
- To evaluate performance at each stage and every level of the organization to track progress towards short-term and long-term goals.
- To correlate the physical and financial aspects of every function, project, or activity. (High performing functions get larger proportions of capital to be allocated).
- To aid in a more effective performance audit
- To align annual plans and budgets with the short-term and long-term objectives of the organization
- To produce a thorough operational document that depicts the entire planning fabric of the programs and prospects, as well as their goals.
Benefits of performance budgeting
Did you know what all benefits can be brought in by adopting performing budgeting in your business? Here is a list of some.
- Performance budgeting helps to increase accountability. Employees have to quantify a particular goal that they would be solely responsible for.
- It reviews the overall operational efficiency of the projects.
- It sets a clear purpose, and indicates with precision, the objective on which the money is going to be spent. The core focus is on the achievement of the overall goal of a division.
- It results in the improvement of the performance of the programs on a continuous basis.
- The exercise of performance budgeting helps in making better financial decisions for the allocation of resources. More productive functions get the maximum share out of the available resources.
- It is designed to motivate employees, enhancing their commitment to producing positive results.
How to execute it? – Process
The following are the steps involved in establishing a performance-based budgeting system:
- Setting of Objectives
- Identification of functions, programs and projects to attain objectives
- Development of performance criteria for various functions and programs
- Preparing financial plans/budgets for each program
- Evaluation and assessment of performance of each program
- Correcting deviations
- Rewarding those programs that performed exceptionally
- Based on results achieved against set standards, allocating resources for the next budget
Step 1: Set Goals for the current period
A company must establish a list of its goals. The goals should be clear to each employee of the company. The successful implementation of performance budgeting is facilitated by clear goals and communication of the same. It is critical to set the objectives – only then can the designated tasks be allocated to the teams based on their abilities.
Step 2: Identifying various process and plans
The next step is to answer this question – What are the various processes, programs, and strategies that can be introduced to achieve the objectives.
Identify the processes and plans, which will help in achieving the objectives.
Step 3: Fix accountability
The employees/staff is accountable for organizational goals. The primary focus of the performance budget is the outcome and not the inputs. Each manager’s/executive’s responsibility should be fixed in terms of what is expected of them.
Step 4: Periodic Evaluations of performance
This step is a measurement of results.
The organization should try to quantify the result based on the outcomes. The organization should see whether the desired goals of the organization are achieved or not. This is to be done for each individual division of the organization. It is essential to determine whose performance was up to the mark and what changes or improvements are required to be made.
Make use of Performance indicators/ performance criteria:
A performance indicator is a standard for measurement. The effectiveness and efficiency of a program/division should be evaluated in terms of these indicators. Some of these could be:
- Significance – How important and relevant is a particular program to the organization?
- Timeliness – Are the assigned tasks and goals achieved on time or are delayed?
- Cost-effectiveness – Were the division’s results/work less costly or more costly than the previous period? What was the level of results based on the given level of resources?
- Accuracy – Were the results accurate and reliable?
- Appropriateness – Were the performance reports of individual departments appropriate to the overall company’s goals?
- Presentation – Are the reports of different departments/divisions clear and unbiased?
Step 5: Set funding for the upcoming period
Based on the performance of different divisions, funds are allocated for the upcoming period. The departments/managers that performed the best, met their targets and could increase the overall profitability of the company, get a larger proportion of the budget amount. Top-performing divisions are given more reward and responsibility for the next period.
Also, the processes where corrections are required should be highlighted. An attempt should be made to correct the deviations in the process and performances (if any) by making required changes.
A few examples of performance budgeting
Below are some instances of how performance budgeting is used.
1. Suppose staff training at ABC Limited (done monthly) helps in increasing the production levels of automobile parts. The targeted production of 93,400 parts was successfully achieved in the current quarter. Now, based on the current performance of the production department, the management may decide to fix a 15% increase in production budget for the next quarter and may allocate more resources to the production department. But if the targeted production of 93,400 parts had not been met, the management would have looked upon the causes for deviation and worked on corrective measures.
2. The allocation of funds and resources in schools or colleges may be based on specific goals. Teachers may earn bonuses/promotions based on the aggregate test scores among their students. Those who showcase a high degree of skill and effectiveness are rewarded more and vice-versa.
3. A few examples of outcomes that a performance budget can address are:
- Improvement in average test scores of a school district
- Decreases in mortality rates of a health program
- Improvement of water quality of a district’s drinking supply
- Reduction in the average number of consumer complaints
- Increase in workers’ productivity
- Increase in the average number of monthly customers or clients
- Increase in no. of products produced per production hour
- Improvement in the quality of goods offered
4. Another example could be a 20% decrease in manufacturing waste to be achieved in the factory. This budget target could be set by the management for improvement in factory operations. Such kind of target, if met would lead to an increase in manufacturing efficiency and a rise in overall profitability. If such targets are met, the management would give bonuses to factory staff, workers, and foremen.
As we have seen that performance budgeting can offer a lot of potential benefits. But still, it may not be appropriate to use in some situations and comes with certain challenges too.
- There may be difficulty in classifying programs and activities.
- It may pose problems of evaluation of various schemes. Choosing a suitable evaluation criterion itself is a cumbersome task.
- Performance budgeting enables only quantitative evaluation and does not consider qualitative parameters. But sometimes the needed results cannot be measured in quantitative terms.
- It is not suitable for long-term business planning.
- The whole system of performance budgeting can become ineffective without a proper and systematic accounting and reporting system in place.
- Performance evaluation can be subject to biases and sometimes, there may be a potential for disagreement as to where the spending priorities should lie.
- There is also a potential for a department to manipulate data. Departments could deceive actual results or could even set easily achievable targets.
Performance budgeting can be a great tool for assessing, evaluating, and appraising the performance of different divisions or programs. With performance budgeting, you don’t set a budget for money; rather you set budgets for performance. Further, you can find a way to integrate performance into the budget decision process as high performance would lead to more fund allocation.
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