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Five steps toward more reality in internal budgets

One of the most pernicious problems about budgeting is that people feel pressure to inflate what they ask for because they expect the person who reviews the rollup of budgets to deflate them. This is the problem of budget padding. Additionally, particularly as the year draws to an end, some people feel obliged to spend their budget so that their baseline for the following year starts at the full amount.

Five solutions (but still only partial) exist to the problem of engorged budgets and splurges (See my post of Sept. 9, 2008: internal budgets with 27 references; and Sept. 12, 2008: internal budgets with 25 references.)

Accountable and involved budget approvers. So that they do not simply rubber stamp the work done below, insist that budget approvers identify at least two specific ways they would reduce the budget if they had to, and one way they would spend more if allowed to. This technique pushes approvers to think about the realism of the budget before them and invest in its accuracy.

Zero-based budgeting. A second method requires those who prepare budgets to start from scratch and to break out the components of their budget (See my post of Jan. 2, 2009: zero-based budgets.). If people who submit budgets have to deconstruct them and justify, say, the six largest components of the budget, it is harder to hide a slush fund.

Budget caps. The general counsel can decree that budgets may not increase more than X%. Held to rigorously, this does hold down the budget and make it crunchier, but it is likely to allow some areas of the budget to increase more than they need to, while starving other activities that have a legitimate need to increase more than X%.

Specify cost drivers. Another approach is to carefully identify the drivers of cost for anticipated activities, and force a critical examination for claimed budget increases by examining the need for those drivers to increase as requested. It is important for senior management to make it clear that an individual’s annual review will suffer if they are found to be predicting cost-driver behavior which is not plausible.

Quarterly reviews. It’s unadvisable to compare budgets to actuals every month, because timing for some expenditures vary in ways that are not within the control of the person who budgeted for them. But over a three-month period, the actual-compared-to-real numbers ought to converge – or some explanation is in order. Periodic reviews, when coupled with the question “Any unexpected changes likely in the coming quarter?” also lower the likelihood that people will spend excessively to preserve their budget for the next year.