Annual budgets are a terrible tool to influence employee behavior and performance. In fact, because they are typically based on prior year, they tend to reinforce existing ways of thinking. If your business is troubled, using the past as a guide is not good.
Budgets are also not helpful as a numerical business plan because they are static. What happens if you have material negative variances in period one? A far better tool for planning and managing is a dynamic rolling monthly model. See a post on this HERE.
Notwithstanding the problems with static budgets, the annual planning exercise can be an excellent tool to persuade employees to prioritize and focus on the things that will most impact profitability.
For every employee with budget responsibility, pick between one and three metrics as their targets for the year. The metrics do not have to be a general ledger line items, but they could be. They can also be key performance indicators (KPIs). See a post on KPIs HERE.
Keep in mind the metrics must be:
- directly in the control of the individual employee;
- measurable and reportable; and,
- limited in number (no more than three) so when the employee wakes up in the morning, their mission is clear in their mind.
The target for success on a metric should be aggressive, really aggressive. But any amount of success should be rewarded and compensated.
Conservatism is the enemy of change. Which scenario would you prefer:
- a reasonable budget of 5% growth in sales and actual growth of 3%, for a 2% negative variance; or,
- an unreasonable budget of 20% growth in sales and actual growth of 10%, for a 10% negative variance.
It seems obvious, but most budget systems reward scenario 1 and penalize scenario 2. Do the opposite.