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When Should You Use Budgeting That is Performance Based ?

written by: Adam Pressman•edited by: Donna Cosmato•updated: 8/25/2011

Although performance based budgeting (PBB) is harder to enact than line-item budgeting, it provides a better picture of what is accomplished rather than what is spent. This method of budgeting increases accountability and is used mostly in the public sector.

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    Power Up Your Performance Management

    Put your money where your measures are. 

    Budgeting that is performance based (PBB) provides the accountability in performance management. While measures of the success of an organization such as key performance indicators, milestone reports and performance reviews are important indicators of how well an organization meets its goals, there is nothing like the potential loss of funding to motivate better performance.

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    Differences in Budget Strategies

    PBB, which is deployed mostly in the public sector, has had mixed results in improving budget efficiency but has improved accountability improvements in public sector activity. The point of this budgeting is to indicate what is accomplished with the funds rather than what is spent. The latter is easier to determine and such line-item budgets are relatively easy determinations particularly in the usual practice of incrementally changing the prior year budgets. It may be easy to state the goals of an organization and perhaps even report some objective measures to prove success.

    More effort is required to establish quantifiable progress, however. Quantifiable outcomes, intermediate measures for success, (often called key performance indicators) and quantified reports on progress are much harder to establish initially. These often change year over year from prior budgets and require an overall strategy to which the budget aligns. Such a strategy, which we will examine later, requires a broad “buy-in" from stakeholders, potentially at every level of an organization, to understand what is required to attain a desired outcome and what funds were used (or need to be used) to do it. This enhances the accountability to outcomes.

    Budget efficiency, on the other hand, is one of the few improvements that can be made to a line-item budget process. Though perceived as a good thing if an organization can operate for fewer dollars than last year, the question that remains is if the organization did a better job than last year.

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    Origins and Components of Performance Budgeting

    The origins of PBB can be traced back to (in regard to US public policy) the Government Performance and Results Act of 1993 (GPRA). According to the Pew Center on the States, “thirty nine states now include performance measures in agency budget requests, and 42 states report some level of these measures online; 22 legislatures reported using performance measures in their budget decision-making."[1] Abroad, the World Bank has supported PBB in its World Bank Treasury Reference Model[2] as early as 2001.

    While there are nuanced differences in the approach to PBB, or performance budgeting as it’s also called, definitions of either include (as stated by Segal and Summers[3]):

    • The result (final outcome)
    • The strategy (different ways to achieve the final outcome)
    • The activity/outputs (what is actually done to achieve the final outcome)

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    How to Base Your Budget on Performance

    Getting the required elements for a budget based on performance is very similar and often done concurrently with an overall strategic plan for use of the people and processes by the organization. Both use the plan and the budget to attain the predetermined goals.In almost every case, a process such as the following must be undertaken and the results shared with everyone holding a stake in the planning or execution of this overall plan.

    When this process is completed in the private sector, it is often called a corporate performance management system, which was derived from the 1970’s management by objective movement. In short, such a system envisions a long-term vision for the organization, scopes out a mission for a shorter term, determines the goals to complete the mission, identifies obstacles and steps to overcome them and provides the rewards for completion and consequences for incompletion of those goals.

    Here are ten steps toward the completion of a performance budget and the aligned strategy to make it real:

    1. Management and other stakeholders create a strategic plan.
    2. Management proselytes the plan and the vision of a successful outcome to inspire action and propagate throughout the rest of the organization a homogenous attitude to success.
    3. At each lower level, managers visualize the steps from completion of the successful outcome backwards to the present moment and identify and disseminate these steps as part of a strategic plan shared by the entire organization.
    4. Management conducts an assessment of the skills (what to do) and knowledge (when to do it) across all departments or cohorts of the organization. This is essential to ensure that the elements required for success by the people are in place.
    5. After completing any skills and knowledge training, management delivers development and motivational processes and measures the retention and application of the training and processes. Indicators of success in retention and application of these skills are determined and listed.
    6. Once the people, their attitudes, their skills and their knowledge are aligned with the strategy, the next step is to determine the specific measurable, attainable, results-focused, and time-bound goals that will capture the desired outcomes.
    7. All stakeholders, management and those who perform the organization’s processes identify any obstacles to these goals.
    8. In concert with management’s overall strategy, this group also determines the action steps to overcome the obstacles, researches how this activity is priced in the market place and budgets for it.
    9. Key Performance Indicators indicating success or at least forward progress in these steps are combined with the steps themselves to make up the procedure manuals and the budget "bucket" for that procedure.
    10. Managers routinely assess where, in regard to both time and progress toward the goals, the budget and plan has to adjust both the budget and action plan. The product of these assessments are periodic reports and more frequent summaries comprising a "dashboard" of key performance indicators which provide a constant presentation of progress toward goals and budget consumption.

    It’s easy to see the difficulty in all this planning and assessment in getting to a budget. This explains the reason line-item budgeting has such entrenched support, particularly in the public sector, where within the relatively short-term of legislators, it’s easier to quantify spending than results with that spending. Those that spend the time on developing an effective strategy to employ all resources of their organization will find that the right funds are in the hands of the right people, doing the right things in the right way to achieve the right results.

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    Automating Your Performance Budget Development

    There is software available from John Mercer (a member of the GPRA committee whose report was cited earlier) called Cascade [5], which is designed to make the burdensome pre-work to PBB simpler. The best part of automating this process is the very fine-grained analysis of what is done by an organization (or what should be done) is required by the software.

    Cascade provides an effective primer as part of their software on establishing a new PBB for an organization or leveraging the tenets of PBB upon an entrenched line-item budget. Particularly for organizations where some mid-course correction of a line-item budget constraint is possible, this blended approach can provide some real value to constrained managers who wish to highlight deficiencies in the line-item budget.

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    Challenges and Rewards in Developing your Budget

    Whether choosing to automate the processes of PBB or not, remember that there is much greater effort required from more people than the budget process you may have used before. When aligned with your overall strategy, monetizing your key performance objectives that indicate you are on your way to the desired outcomes, a PBB puts some real teeth into your strategy and demonstrates commitment to real, timely and measurable results that can be reported easily to supporters, constituents and other stakeholders.

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