Budgeting: Problems and alternative approaches October 2002
In the previous article on Budgeting (Aviation Strategy, July/August 2002,) "Planning," "Budgeting," and "Control" were briefly defined in order to place the task of budgeting in its proper sequence.
We stressed the notion that to be an effective and cohesive force, preparation of budgets should receive the widest and deepest organisational involvement. A finished budget becomes the guide, commitment, and promise of management.
This article expands the discussion of airline budgeting to explain many of the problems often encountered, and alternative approaches to the annual budgeting process.
A fully integrated budget exercise, requiring participation and preparation at the lowest organisational levels, is the best way to instil cohesiveness within an airline.
Because of their involvement in the revenue commitments and the spending forecast decisions required, managers should be able to see the whole corporate picture and their contributions to profit goals.
Knowledge that individual managers will be held accountable for their results sharpens the thought process required for budget preparation.
A high level executive within the finance organisation usually manages budgeting. His/her responsibilities include collection and distribution of all relevant "Level of Operations" data from the proposed schedule, preparation of instructions for all budgeters throughout the company (generally in the form of a "manual" or handbook), and dissemination of the specific instructions and forms necessary to return budget inputs back to the finance department.
Remember that the Level of Operations is the collection of schedule–driven data which triggers the (annual) budget process. The manual, or handbook, provides instructions for each department stating the degree of detail and accuracy required, and the level of explanation demanded with each cost or revenue element. The budgeting forms furnished to each department are tailored to insure ease of data entry by both the budgeters and the finance department consolidators.
The forms, mentioned here, should be pre–printed with necessary account codes and spaces for monthly entries for each account code. Some carriers require that the forms be signed by the preparer as a seal of commitment upon return to the budget office. Some organisations transfer budget data by spreadsheet e–mail. In either case, the data must be viewed as a commitment and must not be changed without the permission of the budget office.
Note that budget input must occur by account code. Budgetary data when compared to actual data will be accomplished by account code. Each responsible manager will be required to explain the deviations from the budget and will be expected to take some form of remedial action as part of the "control" process.
At this point the budget submissions from all responsibility centres are consolidated, and a hierarchical company budget is created. Hierarchical means a consolidated budget is tabulated for each organisational level.
So each major department will see a consolidated spending plan for the whole department. Each manager will see the compiled results for all of the budget centres reporting to him or her.
Within the budget process risks abound. Sales managers may be too conservative in their revenue assumptions; line managers may be too lavish in padding their spending predictions. The net result of the exercise, when all budgetary inputs are consolidated, is a probable corporate financial loss.Budgeting is a heuristic, or trial and error, process. The first cut at a budget rarely produces attainable results. High–level management must scrutinise the budgeted data and re–initiate the process for another try. At this point, senior managers should increase the guidance provided to their subordinates, issue revised spending or revenue objectives, or insist on greater detail of explanation. This process occurs over and over, until the consolidated financial result is acceptable, yet within management’s ability to commit to its plans.
Often the airline’s schedule itself must be reworked. The schedule may have too many loss–making routes, or a mis–allocation of aircraft within the route network, or a region of the network that the airline simply cannot serve profitably. In these situations hard choices must be made. Elimination of a traditional service is always difficult, since staffing, pay levels, tradition, pride and corporate image are often involved. Nevertheless, the airline must never condone a budgeted loss. If an airline cannot schedule and budget a profit, it will sooner or later go out of business. Budgeted losses also weaken the resolve of all employees to produce their work with efficiency and consistency.
Level of detail
Sophisticated budgeting demands that each manageable element of cost and revenue be identified, analysed, and planned. For example, passenger revenue requires assumptions of passenger volume by route, by class of service, by published and discounted fares, adjusted for the algorithms under yield management schemes, and net of promotions, discounts, and commissions. Each of these elements must be identified, quantified, understood, and in the case of commissions, negotiated. Comparison of these assumptions to actual results throughout year must be accomplished to assist in the fine–tuning of corporate strategy and tactics.
The same level of detail is required of costs. For example, the cost of passenger meal service requires assumptions regarding a forecast of the number of passengers and crews consuming meals in flight, the class of meal consumed, the quality of meal service by class, the consumption of supplies (cups, napkins, condiment packs, etc.) and the degree of over–boarding meals. Comparison of these individual elements throughout the budget year will permit service quality adjustments, analysis of wastage, and more intelligent negotiation of catering contracts.
Several methods for establishing future budgets exist. The simplest is a trend extension of existing cost flows for an expense item, adjusted for a forecast of inflation. Regrettably, this technique produces little analysis or understanding of current or future product structure or requirements. Applied to a projection of revenue, trend budgeting fails to adequately account for specific volume changes, fare promotions, or competitive pressures.
The "programme" approach, wherein spending choices are isolated within boundaries, is more robust. In the meal service example above, a budgeter may develop ranges of meal choices and their associated costs for each route and class of service. The selection of the most desirable meal "programme" can be implemented, modified, swapped or eliminated depending on competitive offerings, or other environmental criteria. The benefit of this approach is the ability of management to intelligently choose a course of action, knowing its potential impact on service quality and financial performance.
Another example of the programme approach is found in the technical services area. Maintenance engineers routinely design new repairs for existing aviation hardware. Each new "fix" should be considered a "programme," wherein the sum of the programme costs of maintenance labour, bills of materials, and other outside vendor costs can be compared to alternative repair methods.
Evaluation of the repair scheme may prove that the repair is uneconomical, and that rather than initiate a repair, maintenance management should scrap the hardware and replace with new. Evaluation of programmes of this nature also reveals the need for new tooling and/or test equipment. Investment in additional equipment, amortised over time, may render specific repairs highly economical and thus desirable from a financial performance point of view.
There is no substitute for good budget analysis. From the examples above, providing lavish meal service on routes where no competition exists may simply be a waste of money. And if the technical services group has been repairing parts that should have been scrapped in the first place, no amount of part repair planning/budgeting will provide "bottom line" benefit. At the very least the budget process should point out these mistakes, and thus save expenses before they are incurred.
The "programme" approach to budgeting, involves the development of "decision packages."
An example of a decision package might be a marketing department programme to develop a corporate Internet website, further enhanced with up–to–the–minute schedule information, and the facility for customers to initiate online reservations and ticket purchases.
One example might be the positioning of an additional line maintenance station at a remote airport. Another example might be the establishment, or removal, of an airport business class lounge. In the first case, establishment of a website hopes to increase captured traffic by augmenting the airline’s current channels of distribution.
The analysis of this package should establish success benchmarks. Has the cost of website creation and maintenance been warranted by increased bookings, or identifiable savings in the reduction of use of other channels of distribution?
In the second example, the airline hopes to reduce costly maintenance delays, improve on–time performance, reduce passenger inconvenience expense, and enhance scheduling flexibility.
The third example hopes to improve competitive appeal by creation of improved station amenities, or save expense where a lack of competitive pressure permits.
Has the establishment of a business class lounge increased captured lucrative business class passengers from or to the host airport? Each of the above examples describes an opportunity to improve the bottom line.
Sound budget discipline will thresh out the costs and benefits of each proposal so that the programmes can be ranked against each other for desirability. As part of the budgeting process, management can thus intelligently evaluate competing proposals and allocate scarce funds for selective implementation.
Creation of decision packages is often arduous as the effort demands imagination, discipline, and clear thinking. Often the best results come from departmental "brain storming" meetings, where a group as a whole tests different ways of accomplishing routine tasks or services. Out of these meetings will come the alternatives which, when analysed, can be ranked for profit desirability and budgetary inclusion.
Individual and group self–discipline is key to the effective use of the decision package creation process. Without focus the process stalls. If the process stalls, the whole budgeting process will grind to a halt and become a managerial irritant. Annual budgeting will become a dreaded task rather than a stimulating means of improving airline efficiency and profitability. Creation of decision packages can be fun.
The intricacy of budget preparation will vary from one responsibility centre to another, depending on the complexity and/or profit impact of the items requiring analysis. For example, while of significant expense magnitude, aircraft lease costs are generally known by contract in advance. The fuel budget, on the other hand, is fraught with unknowns: what is or will be the price of fuel? At which location? Should the airline upload fuel at airport "A," "B," or "C?" At what price is a contract favourable? How should the airline use hedging?
Probably one of the least understood departmental budgets is that of Technical Services (Maintenance, Engineering, Inventory and Purchasing). Tech Services often confounds non–technical management because of its spending rhythm (and hence its budget behaviour) seems out–of–sync with the spending of the rest of the airline. Because of the magnitude of Technical Service expenses, the complexity of accounting and budgeting for these expenses, and the often–misunderstood nature of these expenses Technical Services duties and costs will be sole subject of the next article.