Are Budgets Poor Measurements of Performance?
Last week we looked at whether or not budgets provide an organization with control. This week we are going to discuss if budgets are a good mechanism for performance evaluation.
Budgets and Performance Evaluation
In the traditional budgeting model, a budget not only tries to predict the destination but also the path to get there. It tries to predict what obstacles will appear and what resources will be needed to overcome them. With this model, good performance equals meeting the budget, but as we have seen over the last couple of weeks, a budget is a poor predictor of the future.
So when you try to evaluate your business performance with your budget, you are left with the questions. Is this analysis telling me my business is doing well or is it giving me a false sense of security by telling me I'm on the right path when in reality that path may no longer be the best?
For example, if you are planning a cross country road trip a traditional budget would be like deciding three months before hand the exact turns and roads to get you to your destination. You would then evaluate your performance not by reaching the destination but by whether or not you followed that exact path. You would adjust course to get back on the path instead of making sure you are still headed to the destination because the path to the destination under traditional budgeting is just as important as the destination.
This example shows the issue with using a budget to evaluate performance. The path that brings you to your destination isn't as important as reaching the destination. If you are trying to reach Las Vegas from Virginia Beach, you would use a GPS the day of to help you navigate the best way to get there not only based on the shortest route but also taking into account road closures and construction. This way as events change in real time you can adjust accordingly.
The same applies to business. You should set SMART goals for your business (the destination). You then need to come up with an easy way to track your performance to those goals, so that you can make adjustments to your business' direction in real time. Using reporting tools like dashboards and scorecards which are updated automatically so that any employee at any level of the organization can see where the business is headed and make adjustments to their department or part of the organization as needed.
This removes the need to manage employees and shifts the focus to leading employees. Instead of instructing the employee on how to perform their job functions you are giving them a tangible way to see where they are and where they need to be, empowering them to proactively make changes to direct the part of the business they control.
Any plan that is created should be used for decision making but once circumstances change the plan has to change. Therefore, plans should not be used to evaluate performance. The destination is what matters. How you get there is important only because it brings you to the destination. The path to get there should be flexible and easily changeable. Your performance should be evaluated based on whether or not you reached the desination not on how you got there.