How do you decide what the right level of funding is for each department or functional area?

Challenge

You have a sense of how much money (operating expense and capital) will be available in the coming year. Now, in the enterprise budget process, you've got to allocate it to business units and support functions.

Of course, the total of their requests is greater than available funds. They all want more money!

Your challenge is to allocate scarce resources in a way that will optimize shareholder value (or, for government and not-for-profit organizations, the mission of the enterprise).

You know that funding current headcount and expenses (last year plus/minus a percentage) may not accomplish this goal. Past budgets may have funded low payoff activities in some areas, and missed great investment opportunities in others.

What objective method can be used to decide the right level of budget for each organization within the enterprise?

Solution

Ideally, the budget process should decide each organization's budget based on the investment opportunities at hand. It should allocate resources to the best investment across the entire enterprise, then the next best, and then the next after that, and so on until available funds are committed.

This is termed investment-based budgeting.

Obviously, keeping the enterprise running is a great investment. You've got to "keep the lights on." But there may be some lights that should be turned off to free funds for strategic initiatives.

To allocate budgets this way, you'll need to understand the returns on investments in specific organization's projects and services. You may not need to quantify everything, but you at least need to know the products and services you'll get for a given level of funding.

Thus, organizations need to submit budgets that forecast the cost of their products and services -- what they propose to "sell," not just what they want to spend. Their budgets should describe the costs of specific projects and ongoing services, not just compensation, travel, training, etc.

Comprehensive solution....

Other Resources

White paper for CFOs and Budget Directors: Investment-based Budgeting
budgets should be based on the needs of the business, not past years

Case Study: We've Already Got Budget Spreadsheets, Don't We?
Sonoco Products Co. discovered the value of a fully developed budgeting and product/service costing solution (2009)

Audio Case Study (government): Selling a Transparent Budget Is Easy
State of Montana IT finds ready acceptance at every level for its investment-based budget. (15 min)