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Budgeting Best Practices
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process to devise a set of reward mechanisms that directly link employee pay to
attaining the budget. For example, if a revenue budget requires sales of $1 million
per salesperson, there should be a hefty bonus for the sales staff associated with
attaining that goal. Similarly, if an automation project is scheduled for completion
in July, at a cost of $500,000 and an immediate reduction of 11 direct labor per-
sonnel, the engineering manager should be tied to a bonus that is paid out only if
all of these budgeted items are attained. This should be a very clear-cut document
that is an integral part of the budget, one that is reviewed by senior management for
reasonableness. Further, this linkage should be carefully reviewed with all con-
cerned managers several times during the year to ensure that there is no question
about how much they will be paid and the basis upon which all pay calculations
are based. This is an excellent management tool for ensuring that the budget will
be followed and attained.
The only problem with this best practice is when senior management puts
unrealistic expectations into the budget, such as assuming that sales can be dou-
bled without a corresponding increase in the sales staff. When this happens, man-
agers will ignore the budget once again, since they know in advance that there is
no conceivable way they can meet their assigned tasks. Setting attainable targets
is key to making this best practice work correctly.
When implementing this best practice, try to avoid the use of a hurdle bonus.
This bonus is earned only after the company achieves a specific milestone. For
example, a typical bonus package will begin to pay out when a company reaches
80 percent of its revenue or profit target and will stop paying out when 100 per-
cent of the target is reached. When this type of plan is used, participants tend to
“game the system,” using incorrect sales or accounting practices to exactly meet
their maximum bonus payout levels. A better approach is to use a linear compen-
sation plan that avoids any hurdle points, so employees will have no incentive to
game the system. This linear plan would begin to pay out bonuses at a very low
level of performance and continue to pay out at exactly the same proportion of
the target sales or profit levels, with no upper cap on the potential bonus. This
approach goes a long way toward the elimination of employee behavior that is
adverse to a company’s best interests while they pursue large bonuses.

Cost: Installation time:

5–10 USE ACTIVITY-BASED BUDGETING
For many organizations, the existing budgeting system simply does not yield ade-
quate results. Management can fiddle with the numbers all they want, but work-
ing within the existing structure of revenues by product line and expenses by
department is so rigid that there is little room for improving operating results.
Only by using outlandish assumptions, such as inordinate price increases or cost
reductions, can any reasonable profit improvement be attained. As the new bud-