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ALTERNATIVE BUDGET FORMATS AND BUDGET & CONTROL REFORMS
BUDGETING & PERFORMANCE
RESPONSIBITY BUDGETING
ENTERPRISE RESOURCE PLANNING
BALANCED SCORECARDS
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BUDGETING & PERFORMANCE
Performance
Is there a relationship between budgets and performance?
What is it?
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Is Oregon making progress?
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Yes Yes, but No, but No
No
. o
f B
ench
mar
ks
2003 2005
How Oregon Compares
01
23
45
67
To Washington State To U.S. Average
No
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f C
om
par
ato
rs
Better Similar Worse
Oregoniansusing theINTERNET
Weakeningof some
K-12 achievement
trends
3rd Grade Reading3rd Grade MathHigh School Completion (25+)College Completion (25+)
8th Grade Reading
•3rd Grade Reading•College completion
Computer Usage
3rd Grade MathHS DropoutAdvanced DegreesInternet Use
Labor Force Training
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Questions• What do we believe about the link
between budgets and ensuing organizational (Biz/Govt/NFP) performance?
• What is the nature of the evidence or support for these beliefs?
• What are the implications for practice and research based on the findings?
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Ten Things we Believe(we = Fred and Ken)
1. Budgets focus attention – usually on some target
2. Targets should reflect agreement on what adds value
3. Ex-ante budgets focus on spending targets
4. Ex-post budgets [e.g., Responsibility Budgets]focus on performance targets
5. Stable targets focus attention on hitting the target
6. Any target that can be achieved 100 percent of the time is too easy
7. Unit cost targets can distract from focus on organization performance; *ROI* targets focus on balancing cost and organization performance
8. Ex-post budgeting increases internal conflict
9. Conflict can be mitigated – preferably via ethical argument?
10. Improved performance comes from learning a- (Learning requires both perturbation and measurement) b- (More iterations produce more opportunities for learning)
ROI is return on investment - requires difficult, but possible, discussions to define in Govt/NFP org’s.
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Budget Formats: Ex Ante Budgets
Alternative Budget Formats and Associated Features
Format Characteristics PrimaryOrganization
Feature
Orientation
Line item Expenditure bycommodity or resource
purchased
Resourcespurchased
Control
Performance Expenditure byworkload or activity
Presentation of unit costby activity
Tasks, activitiesaccomplished
Management
Program Expenditure related topublic goals
Cost data crossorganization lines
Achievements, finalproducts, outcomes,or consumer outputs
Planning
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Flow of Public-Service Provision
InputsLabor, equipment, structures
Activities, tasks, outputsStreets patrolled, bridgesrepaired, inspections made
ResultsSafe and speedy transportation,security of people and property
Well-being of people
Street Repair Illustration
Input (line items)Tons of hot mixTons of cold mixTons of crushed stone
Performance of tasksNumber of chuckholes filledSquare feet resurfaced
Outcome dataReduction in commuting timeReduction in accidents andassociated costsReduction in vehicle structuraldamage
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These Are ALL Spending Budgets!Managers are
responsible for executing the budget as enacted
Little discretion to acquire assets; no discretion to exceed authorized spending levels
In the language of Responsibility Budgeting, these are all expense budgets
OE & Program Budgets are Discretionary Expense Budgets
Performance Budgets are Engineered Expense Budgets
In the language of Responsibility Budgeting, these are all expense budgets
OE & Program Budgets are Discretionary Expense Budgets
Performance Budgets are Engineered Expense Budgets
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They ALL Promote a BUDGET MINDSET
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Budget Mindset• Focus on inputs (instead of outputs)• Emphasis on securing bigger budgets
and more spending authority. Budget authority is AN ASSET
• Emphasis on spending rates, i.e., obligating budget authority by the end of the fiscal year
• Centralized budget decisions• Little or no knowledge/understanding
of costs -- or accountability for them
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Performance Mindset• Emphasis on outputs (instead of inputs).
Budget authority is A LIABILITY• Manage both operational and financial
performance• Focus on knowing and understanding the
costs of outputs• Reward people for leadership in meeting
operational performance and cost-reduction targets
• Decentralize performance and cost management decision authority
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Budget History: Public and Private
Budgets, in the form of spending plans, are associated with development of bureaucracy and functional organizations
Budgets, in the form of targets, are associated with business
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The Rise of BureaucracyPerfected by Prussians during 19th
Century • detailed centralized materials requirements and
logistical planning (INPUT/EXPENSE BUDGETS),
• control by rules, standard operating procedures, and the merit principle,
• functional administrative design, distinction between staff and line
• decomposition of tasks to their simplest components,
• Sequential processing.
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BureaucracyResults
• made large, complex organizations possible; also made them inevitable
• POSDCORB functions were all treated as separate concerns, performed by staff specialists and coordinated by TOP MANAGEMENT
• substantial staff resources needed to gather and process data for TOP MANAGEMENT to coordinate activities and allocate resources
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Moving away from Bureaucracy/GM
Multi-product, or M-form, organizational structure • each major operating division serves a
distinct product market
Decentralized control • by the numbers, using the DuPont system of
financial controls, return-on-assets target
Coordination• short run via transfer prices• Long run via modern capital budgeting
system
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Responsibility BudgetingThe most common decentralized control system
used by large-scale organizations in the private sector. (a) units and managers are evaluated relative to the
targets they accept, (b) only financial measures are used to measure
and reward accomplishment or punish failure, and
(c) financial success or failure is attributed entirely to managerial decisions and/or employee performance.
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Types of Responsibility CentersDiscretionary & Engineered expense centers
(budgets are spending plans)Revenue centers (intermediate form)Cost centers (budgets are performance targets)
Standard cost centersQuasi-profit centers
Profit centers (budgets are performance targets)
Investment Centers (budgets are performance targets)
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Responsibility budgets I For expense centers the
budget is a spending plan• For discretionary expense
centers, fixed spending targets
• For engineered expense centers, flexible spending targets (i.e., the budget has two components, a discretionary component and a component that varies directly with volume)
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Responsibility budgets II For a cost or profit centers
the budget is a performance target or goal• For cost centers, the target is a
unit-cost standard• For quasi-profit centers, the
target is a quasi-profit measure: (Standard Cost [units delivered] – Actual Unit Cost [units delivered]).
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Responsibility budgets III For profit centers, the budget is
a profit target [revenue – cost of goods sold.]
The budget of an investment center is also a target or goal – usually return on assets [ROA or ROI] or residual income [EVA or RI]
The main difference between investment centers and all other responsibility centers is that the former approve their own capital budgets
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Capital budgeting I is concerned with changes that
have multi-period consequences for the responsibility center in question e.g. investment in new plant or equipment, a
new program, a major process enhancement, etc.
Where cost and profit centers are concerned, some higher authority must approve these kinds of projects. And, each time a project is approved, the targets for the current period should be adjusted accordingly, as should future year targets.
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Capital budgeting II
IN CONTRAST, investment center mangers make these kinds of decisions without the approval of a higher authority. Their budgets are expressed in terms of their skill in managing assets: ROA, EVA.
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Formerly, individual production units were typically standard cost centers; staff units were typically discretionary expense centers. Mission centers were investment centers.
Mission centers in private sector organizations produce final products that are easily priced and that are expensed following generally accepted accounting practice.
In contrast, support centers [e.g., staff units] produce intermediate products and these were, until recently, hard to cost, let alone price, with accuracy. Attempts to do so were often either excessively arbitrary or prohibitively costly.
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Beyond responsibility budgeting
Cycle-time burdening
Cost of Quality Analysis
Balanced Scorecards
BPR
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Modern Control Methods
New developments in management control techniques/Responsibility Budgeting & EVA aren’t good enough (DF/DI)
Businesses in Japan and Germany were producing higher quality goods and services at a lower cost:
JIT, Cycle-time analysis, Cost of Quality Analysis, Balanced Scorecards, and the Rules of BPR
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The German Critique (ABC)
• Narrow rather than comprehensive (making things vs. making money)
• Uses wrong cost drivers (labor burdening)
• Unwillingness to rely on statistical cost measures and estimates
• Poor averaging, especially temporal averaging
• Failure to distinguish between needs of financial reporting and management control
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The Japanese Critique I• Importance of inventories and
overheads, insignificance of labor hours
• Quality• Solution: manage process through
product design and process value management so as to minimize the discrepancy between Process time and Cycle time [inefficiency = 1 – (PT/CT)]
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Process value analysis (PVA)
• Chart the flow of activities needed to design, create, and deliver a service
• For each activity and step within the activity determine its associated cost and its cause
• Determine how the step adds value or, if it is non-value adding, identify ways to eliminate it and its associated cost;
• Determine the cycle time of each activity and calculate its cycle efficiency (value-added time/total time); and
• Seek ways to improve cycle efficiency and reduce associated costs due to delays, excesses, and unevenness in activities.
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Business Process Reengineering
Jobs should be designed around an objective or outcome instead of a single function.Functional specialization and sequential execution
are inherently inimical to expeditious processing.
Those who use the output of activity should perform the activity and the people who produce information should process it, since they have the greatest need for information and the greatest interest in its accuracy.Information should be captured once and at the
source.
Parallel activities should be coordinated during their performance, not after they are completed.
The people who do the work should be responsible for decision making and control built into their job designs.
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BPR reflects assumptions of flexible or lean production (JIT)
• Nobody but the front-line worker adds value (directly).
• Front-line workers can perform most functions better than specialists (lean manufacturing).
• Every step in the value chain should be done perfectly (TQM).
• This reduces the need for buffer stocks and produces a higher quality end product or service.
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BPR reflects modern IT: reduced economies of scale and scope• Multidisciplinary teams, members work together
from start of job to completion• Push exercise of judgment down to teams that do
an organization's work• More equal distribution of knowledge, authority,
and responsibility• Average firm size falling for the last twenty years
(SIC)
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The Balanced Scorecard
Four perspectives Four perspectives …………………………………. ………………………………….
• Financial• Customer• Internal Business Processes• Learning and Growth Perspective
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Learning Critique• Improving performance requires
learning• Learning requires dialogue• About purposes, goals, cause-effect
relations• Opportunities for learning• Measurement, alternative
measurements• Experimentation (perturbation)
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Summary
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Ten Things we Believe(we = Fred and Ken)
1. Budgets focus attention – usually on some target
2. Targets should reflect agreement on what adds value
3. Ex-ante budgets focus on spending targets
4. Ex-post budgets [e.g., Responsibility Budgets]focus on performance targets
5. Stable targets focus attention on hitting the target
6. Any target that can be achieved 100 percent of the time is too easy
7. Unit cost targets can distract from focus on organization performance; *ROI* targets focus on balancing cost and organization performance
8. Ex-post budgeting increases internal conflict
9. Conflict can be mitigated – preferably via ethical argument?
10. Improved performance comes from learning a- (Learning requires both perturbation and measurement) b- (More iterations produce more opportunities for learning)
ROI is return on investment - requires difficult, but possible, discussions to define in Govt/NFP org’s.
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PracticumResponsibility budgeting AFMC
General George Babbitt
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PresentationsGroup 1• What coalition came to support
the initiation of cost management?
• Why did this base of support coalesce?
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PresentationsGroup 2• How did the idea of cost management
come into existence? • What reasoning and persuasive
rhetoric were involved in selling it? • What was it about the people or the
situation – including historical background – that influenced the eventual idea?
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PresentationsGroup 3• Who were the business-area
managers?• What was their part in the cost-
management system?• Why did they apparently perform
their roles in general accord with the design of AFMC’s “cost management system”?
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Guidelines• A presentation should be crisp
– not to exceed 10 minutes• Any case facts should be
presented within the context of the reasoning/argument
• Prepare for questions