6. Budget Control

Operations are run by the allocation of several types of resources. These can include the use of human resources, capital equipment, facilities, and finances. With the exception of some organizations that are run with volunteer human resources, most organizations require finances to manage the acquisition of resources. The organization having a purpose, called a strategic objective, needs to procure resources to accomplish that objective. Finances in the form of cash, lines of credit, or investor capitol are typically used in purchasing resources, managing an operation, and payment of salaries for human resources. In maintaining the operation, these financial expenditures need to be outlined and organized so that executives in charge of the operation can plan for purchases and expenses needed throughout the year. This detailed assessment of planned purchases and expenses is called a budget.

This plan for expenditures is then distributed throughout the organization to appropriate management put in charge of functional areas participating in these expenditures. The chief financial officer of the organization can choose to break out individual budgets for smaller portions of the operation such as divisions or departments within the organization. These budgets will be more specific to those functional areas and will need to be managed by the manager in charge of those functional areas. Because budgets are an outline of purchases and expenditures within a functional area, how these budgets are derived and how accurate they are to actual spending is vital in planning adequate financial resources for the organization. Emphasis should be placed on correctly establishing a budget and controlling the budget throughout the year because this will help ensure the proper management of financial resources.

When you are looking at the ability to control a budget, part of the general feeling of control is having ownership or knowing that you had a part in designing or developing what it is you are trying to control. One aspect of looking into budgets and control of a budget is how rigid the budget is and how firmly the manager has to stay on that budget. A budget might simply be a cost-structuring guideline that allows the manager to get a feel for what’s going to be purchased for general expenditures in the department or on a particular project. If this is the case, a guideline is something you try to shoot for, and it will give upper management an idea of how to cost-structure next quarter’s or next year’s budget based on the outcome of the previous year. Although this works as a budget-estimating tool, this typically is not the way upper management would like to view the managing of a “controllable” budget. Managers need to hold to a budget and try to manage any cost overruns, and this is where the problems start—in how to control a budget!

• Top-down—Budgets are created by upper management and given to lower-level managers to administer.

• Bottom-up—Budgets are created by the lower-level or immediate manager.

When budgets are handed down to managers, the manager has little or no control over the creation of the budget. This is typically more difficult to work with because you simply have to be held to a budgetary number but have little or no control over where the number was derived from and how accurate it’s going to be. Budgets developed with the input of the manager might be better to work with, because the manager has generally more detail about the department or division and can give a more objective assessment of what that budget might be.

In some organizations a budget might be based on historical data from budgets used in the past for a given department, or input from other functional managers. This would be considered a hybrid between the manager fully establishing his own budget and the budget being passed down; the manager might have some say in it but will not dictate the overall construction of the budget. In any case, a project or department will have some form of cost structuring that will need to be established based on what is being accomplished within that department or project.

Upper management, when handing down a budget to a manager, will want to see the manager hold to the budget as closely as possible. This in turn gives members of upper management a feel for how well the manager is able to control her project or department, in addition to giving them a feel for whether the person actually has the capability of controlling a budget versus just reporting it. Upper management, with or without help from the manager, has established a budget and wants the manager to stick very rigidly to that budget and can in some cases be reprimanded if the manager steps outside of the budget boundaries. This is especially difficult if the manager did not have much say in developing the budget, but control of the budget can still be possible even under these more rigorous requirements.

When managers have the ability and are allowed input on developing a budget, they have a tendency to be more proactive about managing the budget and feel a sense of ownership.

This approach is usually preferred by managers because they then have the complete discretionary capability of analyzing most of the details within a department and know they are putting together a much more accurate budget they can actually stick to. Depending on the skill of the manager, budgets can be established poorly because the manager simply is not skilled in how to estimate costs; in other cases the managers does very well and is educated, experienced, and skilled at cost estimating and structuring a budget. This is actually the best way an organization can establish budgets and have managers maintain control over their budgets.

In either case, whether a budget has been passed down from upper management or has been established by the manager, it has to be clearly understood by the manager whether or not the budget has to be strictly followed or is simply a guideline for the manager to stay as close to as possible. This is important when it comes to budget control because there are some controls that can be used to manage a budget, keeping things strictly within its guidelines, whereas other tools simply manage a budget from more of a guideline standpoint.

Managers who simply have to report on budgetary spending find it easy because there are several channels from which they can derive this information. This can be done through status meetings, during which invoicing and reports from procurement, finance, and accounting will show what is happening financially within the department. This unfortunately only gives the manager information about what has already happened, and if spending has gone outside of what the budget was intending, the manager will be held accountable and will need to answer for why the spending is different from what was budgeted. This makes life hard on the manager, and at this point the manager might feel that although he has accurately reported what has happened, he has little or no control over what has happened. He might feel as though he cannot fix, mitigate, or eliminate a problem and therefore has no control. That is why this chapter is focused on establishing tools and techniques to help managers understand that they can control a budget and not simply report on it.

There are five essential areas that have to be considered within the control mechanism that will have to be done in order to successfully control a budget. These five elements of control consist of the following:

1. Estimating a budget to create a baseline

2. Monitoring

3. Measuring

4. Adjusting

5. Verifying

Budgetary estimating should be as detailed as possible to allow the manager more opportunity to view specific cost elements within the department or project. The more detail within cost structuring, the more ways a manager can control variations in cost.

Here’s another look at the two forms:

• Top-down—Estimating typically tends to be more generalized and more compartmentalized in structure, which yields a more “overview” look of what will be spent within the department, but not necessarily having the detail that most managers would like.

• Bottom-up—Estimating typically has the capability of more detail, giving the manager the most amount of information about purchases and cost structuring and giving the manager the most amount of leverage in control.

In either case a budget will be established and the manager will need to hold to this budget to some degree. If the manager has the bottom-up estimating capability or cost estimating from within the department, this should be used to its fullest extent. Actual data can come via several sources such as these:

• Actual invoicing

• Prior historical purchases

• Real employee costs

• Subcontractor costs

• Contractual agreements for procurements

There might also be subject matter experts available within the department who can give insight as to more accurate cost figures the manager can use. The manager should always strive to look for as much detail, from as many resources, as possible in order to get the most accurate estimates in establishing a budget. There might even be cases in which departmental managers have notes or lessons-learned documents that might give insight into prior problems with purchases, cost estimating, or contracts that were mistakes in the past; these can help the manager avoid making the same mistakes again. This can be valuable information because it can help mitigate or eliminate possible risks within a budget that might result in overspending or having to make purchases based on things that have gone wrong in the past.

This detailed information also sheds light on the possibility of risk items or uncertainties that have the capability of costing a department money, and gives the manager an opportunity to pad a cost estimate that allows a budget to have money in case the risk actually happens. This is an area where managers can estimate a budget that actually allows for uncertainty and risk. When the budget status is reported, it shows on budget even when risks might be occurring if the manager has allowed room for those within the budget. This is an area where a manager has the ability to control a budget and not simply report on a risk happening that will be out of the budget.

It is important to know how accurate budgetary numbers are, as this will indicate how much padding to use in estimating. Some padding might be from known historical problems; other padding might be simply used for protecting from potential risk. It is better to plan for risk and to not have to use the extra budget than it is to not plan for it and end up needing it and going over budget.

If risks were budgeted for but did not happen, this allows the manager to show that he is under budget. Managers might need to be careful with this because in some organizations annual budget approvals are based on how well a manager is able to stay on a budget, which includes going too far over or under.

In some cases budgets might be cut because not enough money has been spent. The manager needs to show that there was cost budgeting factored in based on prior risk events typical within that department. The manager was being responsible in covering risk within the budget. It should also be noted that managers should try to lobby for this type of estimating because it does allow for more accurate budget projections. In most organizations it’s better to come in under budget than over. What’s also valuable for the manager is to show that the manager not only is responsible in paying attention to detail, but also has a plan for how to deal with risk.

This is why the baseline is vitally important—it gives the manager a way to monitor department spending and measure it to see how things are going. Project managers have used the baseline tool for decades as a primary weapon to control project costs. The manager can better assess what controls are needed based on how far or close the actual spending is to the original baseline estimate. When the budget is monitored and measured on a continual basis, this allows a real-time assessment of budgetary spending and gives the manager the quickest indication as to trends in spending and potential problem areas that might need to have adjustments made.

Some organizations set an annual budget of operating expenses for departments at the beginning of the year. One might ask whether changes are allowed within the budget if it was used to establish a baseline and will be used throughout the entire year; the answer should be yes. If the answer is no, meaning that changes cannot be made in the budget throughout the year, the manager will need to have other control tools in place to keep departmental spending on budget. If the organization can allow changes throughout the year, this might allow for the budget to be updated and the manager would be allowed to change the baseline to reflect those changes.

One of the best tools a manager can have in understanding when and how to control the budget is the baseline. The fewer changes to the baseline the better, because it is supposed to represent an accurate picture of planned spending to be used to compare to actual real-time spending. Maintaining the integrity of the baseline will ensure that controlling efforts are actually justified and show how much control really needs to be implemented. Using the baseline tool helps the manager control costs and saves the organization money in staying on budget.

After a budget is in place, the department manager must have tools to monitor the purchases, expenses, and salaries of employees happening real-time. This is important because this information will be compared against the baseline to see whether changes or adjustments need to be made to stay within the budget. The manager must know the budget well enough to know what information for purchases, expenses, and salaries will need to be obtained and where to retrieve it. Monitoring can be in the form of status meetings, having e-mail updates daily or weekly, or physically going to the areas where procurements and expenses are actually happening to get this information as it becomes available.

Monitoring will look at two directions of the spending path:

1. Monitoring procurements and expenses that are in process or have already occurred

2. Monitoring the schedule for future planned spending to ensure that it will be done as planned and look for any planned risks or potential problems that might be approaching

In monitoring spending that is currently in play or has already happened, assessments are made as to whether spending is still on budget or damage control needs to be implemented. This might require adjustments or changes in immediate procurements to control any further problems and/or controls for further spending to avoid problems.

1. Documenting actual procurements and expenses

2. Comparing actual data to the baseline to see whether adjustments need to be made and reporting the status of budgetary spending to upper management

Measuring actual spending compared to the baseline data can reveal how much control will be required, if any. The primary tool used in measuring is the comparison to the baseline data. Depending on the complexity and structuring of a department, some items might need more monitoring and measuring because variability can change without notice and very quickly. Other items might not be as subject to change or might not occur as frequently, so monitoring and measuring will be in place relative to the frequency of occurrence. As with cost estimating, measuring of real-time data needs to be as accurate as the baseline to make valid comparisons.

If cost estimates were detailed and actual cost measurements were very broad, this would not give you a very accurate comparison to your baseline. Measuring accuracy should match the level of accuracy in the original estimates and baseline. When you are gathering information, care must be taken if you are using second- and third-hand information because this can also be an area of risk and can result in inaccurate reporting of real-time information. When gathering real-time information about individual cost items, make sure that it includes everything the original cost element included. For instance, if the original cost estimate of an item included delivery charges, sales tax, or special conditions, evaluate the procured item to see what was “actually” charged. It is imperative that the manager try to get firsthand information and the most accurate information possible so that this can be used in comparison to the original estimate or baseline to more accurately gauge how well spending is performing in the budget.

Techniques to control costs within an operation include these:

1. Evaluate pricing—Consider best pricing versus a qualified vendor list. Depending on how rigid the organization is on qualifying vendors, there might be better pricing from nonqualified vendors who simply need to be qualified. This can be a much more difficult process with organizations that have a very strict qualifying process. It doesn’t hurt to ask!

2. Verify specifications required—Make sure that those who are purchasing understand what they are purchasing so that specifications, requirements, and the scope of the purchase are made correctly. If little attention is paid to the details, this can present problems when items arrive and do not meet the requirements. This requires returns and more delays, all costing time, resources, and money.

3. Know who is authorized to purchase—If critical purchases need to be made, ensure that those making the purchases are trained and qualified to do so. Some purchases might require special negotiation or contractual agreements. Others might simply require knowing where to go for best pricing or shipping requirements.

4. Make or buy—Knowing when to use internal versus external resources to accomplish a procured item is very important. The externally purchased item is typically thought to be more expensive, but only if there are internal resources capable of making it cheaper, faster, and with equal quality. In some cases those internal resources are not available and external purchases are necessary. When internal resources are used that are not as capable, it might be more expensive given the time, lack of tools, and lack of experience, as well as any rework it took to complete something. This can also apply to using subcontractors to perform processes. Process demand and resource allocation will determine whether internal or external staff will be chosen to fulfill that need.

Making adjustments is about doing what it takes to address the cost element of something that has gone over budget. When we focus on what drives the cost of something, this can take us into other areas of indirect or periphery influence of cost and surprising ways you might make adjustments. With this type of adjusting, the manager needs to think out-of-the-box in being creative and understanding the item that has gone over budget. This also requires understanding the things surrounding the item that can have an influence on cost to which adjustments can be made, bringing the cost closer to the baseline.

Looking beyond the simple cost of something should have the manager asking questions like these:

• Are all the specific requirements listed that drive a cost actually needed?

• Can you benefit from using a vendor that, based on location, will result in less expensive freight charges, or from shopping vendors that have free shipping available based on the types of purchases?

• Can setting up scheduled releases of shipments allow for volume pricing based on larger purchase quantities, but establishes controlled delivery?

When evaluating the number and types of human resources required, the manager should pay close attention to the complexity of the process and skill sets required to perform the process. Human resources with a marginal skill set might take longer to perform a task and in the long run might cost more money than a more skilled and experienced resource who could do it in a shorter period and possibly with higher quality. This type of assessment of human resources should always be taken into consideration to streamline the efficiency of the department, as well as completing the processes required. Having an expensive, highly skilled resource allocated to a process might be overkill if a lesser skilled person can do the process just fine but at a lower cost.

The manager should also monitor the use of contractors and how contracts might be set up. Hiring a subcontractor to do a portion of work within the department might have a contract cost associated with a particular level of work, but that contract could be renegotiated to alter some component of work or possibly a different contractor could do the work for less money. The contractor might be working with resources in the department who were pulled away from their tasks, indirectly costing the department more money because of resources having to help the contractor.

When looking at the budget and monitoring what has to be purchased, managers can look into the details of purchases, ask the questions before things get purchased, and try to be ahead of purchasing to make adjustments if there is an opportunity. Just asking the questions puts visibility on purchases and accountability on those requesting the purchases before they are made to avoid overspending. This also gives the manager more control over spending and the budget. This might not result in any lower costs of items, but it ensures that the procurements and expenses happening within the department are justified and represent the most cost-effective option.

This is why monitoring and measuring are vital tools managers need to have in place to better understand how they can truly control the budget. When these tools are in place, managers have the information they need to look ahead and make accurate assessments as to the procurements, contracts, and human resource allocation that will actually fall in line with the objectives of the department, as well as matching the estimates laid out in the budget for that department. Managers feel much better about their level of control when they can make adjustments before things happen and can see the outcome of their action staying on budget.

1. The manager can see how much adjustment was actually made and whether it was successful in accomplishing what the manager was trying to do in lowering costs.

2. The manager is assured that his strategy of making adjustments actually does work.

3. The manager will see that an adjustment affected only what was intended to reduce cost and did not cause other ripple effect problems elsewhere within the budget.

This is very important as managers begin to understand how they can make adjustments and become comfortable in being able to proactively or reactively start controlling their budget. Verifying adjustments gives direct feedback to the manager that adjustments were actually made and they can realize a cost savings that actually happened. Verification can also be a necessary tool that will help the manager to explain how adjustments were made, and for what reasons, and to show a level of competency in being able to control budgets.

There are various types of contracts, but the most common are fixed-price contracts. This is where both parties agree on the deliverable and the price will not change. This puts most of the risk on the party producing the deliverable for the price agreed on in the contract.

The drawback is the rigid nature of contracts and the inability for managers to make necessary adjustments to control the budget. One primary concern is in the ability to terminate a contract if needed. Both parties must be convinced that in agreeing to the terms of the contract, it’s in their best interest before they sign. After the contract is signed, the primary way out of the contract is with a breach of contract. This is where one party does not fulfill his part of the contract and the other party can request a termination of contract.

Managers must know that they cannot simply turn on and off contracts at will if the terms are not suitable—these are legally binding agreements! If there are contracts relative to subcontractors, equipment lease/rentals, or procurement of material required within the budget, the manager should pay very close attention to those items because after contracts are signed, although some things can be changed through a change process, they are very difficult to cancel.

When controlling or making adjustments, the manager could look at altering the conditions of the contract through a change process to see whether lowering the cost within the existing agreement is possible. This could be as a result of learning that the deliverable could change or supplies and materials might be found at a much lower price and a new contracted price could be agreed on. Because making changes to an existing contract might or might not be possible, the manager can use this information to look forward to future procurements. The manager can evaluate purchases that have not been made and possibly streamline through cuts within the budget to make room for overcost on items already purchased. This is another critical tool that managers can use to again control a budget. Control is about making changes and adjustments that allow the budget to stay on its original estimated values. If changes cannot be made to things already purchased or bound by contract, then changes can be made to things that have not yet been purchased. This again has the manager thinking out-of-the-box and looking at his entire budget for areas of adjustment.

Evaluating past expenditures to identify problems and then looking ahead on the budget is another proactive way to help streamline certain procurements or reevaluate contracts or agreements. Contracts can also be used in making adjustments in the budget by shifting a make-or-buy decision which allows for a task or an item to actually come in less expensive. This is an interesting area for organizations to evaluate because many organizations find themselves in a situation in which they do not have resources or material to do something in-house and have to contract or buy from outside the organization to fulfill that need.

In other cases organizations have human resources, materials, or equipment available to perform tasks in-house at lower costs, not needing to go outside the organization to fulfill those requirements. The manager looking ahead on her budget has the ability to assess or analyze a make-or-buy situation that might help improve the budget. This will also have the manager evaluating resource capability versus availability. In evaluating cost reduction, it might be less expensive to do things internally, whereas in other cases it might be less expensive to go outside. A thorough analysis should be done in either case to see how improvements can be made to the budget regarding these types of procurements and the need for contracts.

• In the reactive mode—The manager makes adjustments real-time or looks at what was purchased to see whether anything can be renegotiated, stopped, or repurchased to fix an overbudget area. This is more of a damage-control approach.

• In the proactive mode—The manager looks forward within the budget and analyzes whether things could be done slightly better or could be done at less cost. This gives the manager more power and leverage in control because things have not happened yet and changes can be made to avoid problems or simply make better choices. This is more of a damage-avoidance approach.

In either case, the manager knows that he has the tools to not only develop the budget, but also to monitor and analyze spending to ensure that he stays on budget.

These five areas—establishing a budget, monitoring, measuring, adjusting, and verifying—are all part of controlling a budget and are some of the most powerful tools the manager can have with regard to departmental budgets.

• Properly cost estimating and budgeting for risk is the first step a manager can take in actually controlling a budget.

• When risks are fixed within the budget and the budget can be reported as stable, the manager feels as though she has more control over the budget.

• The baseline is a very important tool the manager can use to track the success of control efforts measured against the original estimate.

• The manager must set up a regularly scheduled flow of real-time budget information to compare to the baseline; this gives the manager the quickest indication of problems and the fastest response time in addressing issues.

• Monitoring will also be directed to future planned spending to see whether problems might be imminent or whether risks that have been identified need to be addressed. This level of monitoring is very important because it allows the baseline to be used in mitigation of problems, which is proactive versus reactive managing.

• Contracts can benefit the manager in not only estimating but controlling budget items as contractual pricing should not change or be influenced.

• Knowing that budgets can be controlled gives the manager a sense of ownership and power over spending in not just reporting budget outcomes, but trying to control spending to stay on budget.