Organizational performance challenges

How budgets, cost models, management dashboards and continuous improvement are used today — and what needs to change

By Hugues Boisvert, CMA, FCMA

Between March and late June, the CMA International Centre for Studies of Business Processes analyzed the challenges in organizational performance related to budgets, cost models, management dashboards and continuous improvement experienced at a variety of firms headquartered in Quebec. The goal was to determine how these techniques contribute to organizational performance management.

The findings were rather interesting. Often, these so-called management accounting techniques resembled management accounting in name only. They tended to embrace the objectives of financial accounting exclusively. Of the four techniques studied, budgets were frequently used solely to project financial results; their contribution to the implementation of corporate strategy was non-existent or very weak. The cost models were reduced to simple pricing systems intended to evaluate inventories, rather than true models representing the organization’s activities. Indicators found in management dashboards are identified and developed by the company functions and are in no way integrated in financial management. The same is true of continuous improvement projects, or Kaizen projects, which are implemented completely outside the finance function.

Better use of budgets

The challenge that was raised by our research in this regard was to encourage organizations to use budgets to apply corporate strategy. Our interviews identified two major roles associated with budgets: monitoring financial projections and managing strategy. Several executives told us: “There are forecasts and there are plans.” The budget also has an impact on manager motivation in that budget targets are often used to establish compensation.

Budgets are used to monitor financial results in nearly all companies. Only when the anticipated results are stable and easily predictable were we told that there would not be a budget, that this would not change anything. The budget thus contributes to managing financial resources by tracking financial projections. One such practice that was evaluated favourably is that of the continuous budget, whereby at the end of each month, not only are the projections of the following months adjusted but the budget of the twelfth following month is added (known as the 12-month rolling forecast).

When production depends on sales, the monitoring of financial projections is essential; several executives considered the budget their bible. Budgets therefore served to plan production and the use of human and material resources, and also to manage cash flow. Externally, budgeted financial statements were useful for third parties, notably to analyze anticipated performance, just as financial results inform an analysis of confirmed performance.

In contrast, the use of the budget to implement strategy — a management activity — wasn’t as evident or simple. In this case, managers developed plans in line with the strategy defined by management. The budgets then monitored the implementation of plans and oriented managers’ decision making. This role of the budget was often difficult to achieve for several reasons. Budget targets were transmitted to managers of administrative units, but the financial results derived from the plans proposed by managers didn’t always please top management. Managers were then asked to redo the plans to generate more satisfactory financial results. It’s easy to imagine that managers ultimately provided the results desired by top management.

Assuming that the strategy was communicated effectively to managers, the plans that best corresponded to the strategy may not generate the results anticipated by top management, who nonetheless insist on obtaining better results. The plans that provide better results may not be realistic, but top management would accept them because it helps them anticipate better results, even if they are never achieved. Therefore, the budget was often used not to implement the strategy, but rather to create pressure to achieve the financial results that top management wanted.

In small and medium-sized enterprises (SMEs) that don’t have hierarchical levels, this phenomenon of exerting pressure through budgets was generally not present, and plans were usually formulated in harmony with the strategy. Top management didn’t question the plans that it produced, even if they didn’t yield the desired results over the short term.

Lastly, although several executives opted to differentiate plans and forecasts, this distinction of the two roles of budgets was not obligatory. Often, they were combined such that the imperatives of one (financial monitoring) prevailed over the other (strategy). In addition, when individual performance was gauged by the attainment of financial targets, upon which compensation depends, the budget no longer served the strategy.

The role of the budget in implementing strategy deserves to be re-evaluated because implementing the strategy is a major challenge of performance management for organizations.

Cost models

The challenge to address in a discussion of cost models is encouraging companies to develop veritable models to represent the firm’s activities. In theory, a cost model must describe cost behaviour, i.e. identify the factors that make costs vary and that can simulate costs when these factors vary. The manufacturing costs obtained by assigning direct production charges and allocation of indirect charges is the simplest model of manufacturing cost behaviour. In this case, volume is the only factor in cost variation. Currently, however, the cost model is expected to produce a description of the main activities that generate costs, the identification of drivers that affect consumption of resources by activities and the performance indicators related to outputs. The objective is to produce new information for operations management.

However, the data we gathered shows that, for the majority of companies, costs are calculated as part of financial accounting, and companies haven’t developed or implemented a system of management accounting distinct from financial accounting. In addition, in the context of an innovation and growth strategy that centres on acquisitions, executives aren’t aware of the potential benefits of a cost model that goes beyond associating direct production costs with products. In addition, executives at companies that have implemented an integrated management information system (Enterprise Resource Planning, or ERP) don’t feel the need for other cost-related information.

Moreover, the few companies that adopted activity-based accounting claim that they are very satisfied with the value of the information obtained and affirm that this information is a determining factor in the performance of their organization.

What can we learn from these observations?

After 15 years of activity-based accounting, the value of models that represent company activities remains to be proven. Activity-based accounting must not be developed uniquely as a cost accounting system. Rather, it must depict company activities. Specifically, it must describe the processes in the value chain, relate resources used with the help of drivers associated with cause and effect relations, and measure their performance.

While the connotations of the term financial accounting are universally understood, the data related to management accounting indicates that this activity is interpreted in diverse ways. Management accounting, intended to produce information useful to management, doesn’t have the same significance for many financial managers and function managers within the same organization. The responses to questions about management accounting illustrated variance in opinions between the financial manager and the functional directors of the same company as high as 53%, 57%, 62%, 71% and 83%; what some consider management information, others do not.

Companies that have developed representational models are satisfied with the information obtained and recognize the value of these tools for decision making.

Management dashboards

The challenge that companies face in this regard is to develop integrated management dashboards made up of indicators that predict future performance. By definition, management dashboards are central to organizational performance management. They include indicators that, in theory, serve to guide the company toward better performance. It has often been said that one can’t control a company without having an idea of the terrain on which it is travelling, without indicators that guide managers in the right direction — consistently, with the strategy formulated by top management.

Nonetheless, in most of the cases observed, administrative units developed their own dashboards quite autonomously, irrespective of corporate strategy. In addition, most of the indicators used illustrated past performance. Management dashboards were therefore presented as a tool at the service of each of the administrative units individually, and as a rear-view mirror into past performance. Very few companies deployed management dashboards in an integrated way and cascaded them throughout the organization, from top management to all administrative units. Indicators that are drivers of future performance were seldom used.

Because strategy implementation is one of the main organizational performance challenges, and given that a good portion of the management information produced by the finance function is useless or isn’t used to manage functions, a thorough analysis of the deployment of the dashboard as a means of applying the strategy produced by top management is required in most organizations.

Continuous improvement

The challenge is to integrate continuous improvement projects in a strategy of continuous improvement.

While nearly all companies examined carried out Kaizen projects, the finance function participated in these projects very rarely. These projects were largely individual initiatives, often initiated and controlled by top management. In general, these initiatives were beneficial to the company and motivated all of the employees to become involved in pursuing organizational performance. They were often very stimulating for managers, but, similar to management dashboards, were implemented outside of and most often independently of the finance function. They were not part of the management accounting toolkit.

Is this important? The major organizational issues in performance management include the evolution of the finance function toward a business partnership. In fact, full integration of the economic dimension of Kaizen projects must take place through a business activity analysis performed by the finance function in a business partnership with the other functions in the organization. The challenge for companies is to integrate continuous improvement projects in the implementation of the strategy and the  other performance management tools of the organization.

In many of the organizations studied, budgets and cost models were used in financial accounting exclusively, whereas management dashboards and continuous improvement projects were implemented without the participation of the finance function. Therefore, in these organizations, the finance function is always dedicated solely to the statutory activities of reporting and financial management. Accountants are thus limited to a minor role in the organization.

After reading Alexander Mersereau’s article in this issue, one might wonder whether the finance function managers in organizations aren’t submerged in financial accounting responsibilities to the extent that they simply abandon the roles of informing and observing other management issues. In many organizations, is management accounting, revived by the work of Johnson and Kaplan, being squelched before it can blossom?

When the budget is limited to monitoring financial projections and cost models, and to a pricing system to evaluate inventories, and when management dashboards and continuous improvement projects are developed and implemented totally outside the finance function, the evolution of the finance function toward a business partnership is questionable.

Conversely, organizations that transform the finance function into a true business partnership use the budget as a means of implementing strategy, cost models become true representations of company activities, management dashboards become tools used to manage implementation of the strategy and continuous improvement projects are integrated in a genuine strategy of continuous improvement.

Hugues Boisvert, Ph.D., CMA, FCMA, (hugues.boisvert@hec.ca) specializes in benchmarking, accounting and activity-based management. He is head of the CMA International Centre for Studies of Business Processes and a full professor at Ecole des HEC.

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