Budget confidence from the bottom up

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A solid house is only as strong as its foundations, and a business and its budget is no different. With rising input costs, more competitive industry structures and lower pricing expectations, there is an ever-increasing emphasis on efficiency and productivity for energy and water businesses. It therefore isn’t surprising that a consistent theme emerging across the water industry this year has been on improving budget forecasting, development and management processes. A strong and consistent recommendation for these businesses has been to develop the tools and appropriate cultural alignment necessary to enable robust bottom up budget management approaches.

What is bottom up budgeting you may ask?

A bottom up budget is just what it sounds like. Budget holders are given the opportunity to participate in the process of developing their own budgets from the ground up – determining how much time, resource and other input costs (i.e. materials, corporate, contracted labour, etc) are needed to achieve each of their planned objectives – which is then rolled up into the overall operating budget of the business. This contrasts with the alternate top down budgeting approach, where budgets are prepared and typically pushed downwards from last years’ budget figure by organisational leaders to savings in magnitude less than CPI, as supported by historical data and managerial judgements.

Pros of bottom up budgeting:

  • Bottom up budgeting is a critical tool for businesses to gain a detailed understanding of the impact of key cost drivers on resource levels and other costs across operational areas of the business.
  • Forecasting and budgeting in a bottom up fashion has the strength of forcing attention to specific categories of activity, expenditure and output (i.e. activity-based costing), and revenue, which is necessary to plan and subsequently manage the activities of individual reporting units, departments, plants, etc.
  • Budget managers can have a higher confidence in the impacts of reforecasting cost allocation throughout the year and can adjust programs more easily and understand the impacts of cost pressures and additional constraints.
  • The “hollow logs” (e.g. management overhead, IT licence charges) which can inherently be hiding within many top down budgets are exposed and allocated out at an activity level.
  • Process optimisation and business transformation projects are ready-armed with the data and insights necessary to acutely determine where cost pressures and resourcing bottlenecks are occurring in order to deliver business enhancement and continuous improvement projects.
  • Bottom up budgets typically have sufficient clarity and definition to be confidently benchmarked against other internal functions or industry peers, and provide the basis for continuous improvement.

Cons of bottom up budgeting:

  • Make no mistake, lots of hard work is required to measure and monitor bottom up budgets – placing more pressure and necessity upon having the right organisational culture to commit to bottom up budgeting, uniquely understanding all cost inputs, and having the analytical grunt and/or appropriate systems to collect and manage cost data.
  • Bottom up budget builds can also be fundamentally flawed by their inherently overly specific nature – potentially facilitating the unconscious (or conscious!) build in by managers of compounding margins over what could otherwise have been more rationally aggregated and costed activities.
  • This proneness to the “junk in, junk out” scenario can lead to forecasting of resources beyond what is absolutely necessary, for fear of undercutting business needs through subsequent low-level forecasts (but then again, that can happen from the top-down too!).

Fundamentally, a pragmatic approach to bottom up budget development is possible, so long as adequate business tools and an appropriate cultural alignment has been enabled to deliver and manage the required approach. At the end of the day, knowledge is power, and informed and empowered managers ultimately make the best decision-makers.

Bottom up budgets in action

Benchmarking projects

Using bottom up budgeting to distil businesses objectives down to the activity level creates the enabling framework to support the comparison of a business to domestic and international peers (i.e. activity based costing is accurately measurable and comparable to other businesses).

Programs such as MHCs Civil Maintenance Process Benchmarking offering for the water industry provides an example of how improvement targets can be rationally developed based upon peer comparisons to activity-based cost and service level data and leading practices for various maintenance activities (Figure 1).

 

Figure 1 – Built up Cost per Task comparison

Supporting continuous improvement

Continuous improvement projects benefit significantly from being able to be linked to stated initiatives definitively, with measurable outcomes derived at an activity-based level through bottom up budgeting. MHC has delivered multiple continuous improvement processes for clients to this effect, whereby improvement initiatives are directly linked with quantifiable activity-based improvement outcomes.

These measurable benefits can be linked to one or all of Cost, Productivity, or Service Level improvement outcomes and enables target benefits to then be calculated and tracked and refined throughout implementation (Figure 2).

 

Figure 2 – Continuous improvement cost reduction by cost item and initiative

Responding with confidence to changes in circumstances

There are times in everyone’s budget when a series of unplanned events put pressure on budgets. Response during these times require rational and informed decision-making regarding what discrete items of work can be reduced or removed to offset the funding that needs to be reallocated to rectifying the unplanned events. Bottom up budgets provide the database required to make these calls with confidence.

A similar approach can be used to model a variety of budget versus service level scenarios (i.e. the detail in the bottom up budget allows you to vary cost elements per activity dependent on the required service level).

Ultimate rewards

As Drucker would say, “if you can’t measure it, you can’t manage it”, and the bottom line is where the buck stops. A business with Managers acutely aware of and at the reigns of their budgets can be steered safely, maintained regularly, and is most importantly, prepared and open to the benefits of future optimisation and transformation projects. Put simply, if you can look good from behind and the bottom up, you know you’re on a solid foundation and pathway to ongoing success.