Unchallenged assumption #4 Project-based funding
Project-based funding is over-used and spending often becomes disconnected from its purpose. Let's look at how it works, the assumptions and what alternatives there are.
In the first post in this series, I introduced the idea of unchallenged assumptions in organisations that had become entrenched as the way work is done such they have become very difficult to challenge, even when doing so would be very impactful:
Seven unchallenged assumptions stunting your company's growth
The unchallenged assumptions I had identified were:
Project-based funding.
There are others, and I encourage you to share your examples in the comments, but these were the most prevalent ones I’ve experienced.
Project-based funding
What is Project-based funding?
Note: a disclaimer - except for a few places where it felt most apt I have tried to avoid using accounting jargon. I have attempted to use the most accessible terms to describe the common mechanics of budgeting in organisations to help the reader how it works in practice.
Project-based funding is when funding assumes timebound, fixed spending to provide something valuable to an organisation. It generally assumes it will occur sometime in the budget period - usually annually. Forecasting will often try predict which month the spend will occur and monthly forecast updates will update this based on any indication of earlier spending or delays to the spending. The use of Project-based funding most often is the result of annual budget planning processes and considerations of capitalisation and other factors.
A Project-based approach to funding is closely linked to a Project-based organisation of work - the two often go hand-in-hand. I say often when it seems like the answer should be always because of the different perspectives between the accountants in the finance team and the managers of projects. Project managers or other roles managing a budget for a project will usually see spending as starting with the commencement of the project and ending with the completion. Any accountant knows that expenditure to the relevant cost categories for a project can often occur well before and well after these events. This article takes the wider view because how the funds are accounted for is part of what creates perverse incentives and disconnections of spending from its purpose.
Almost all organisational budget planning features a base expenditure for running the business and project funding on top which represents the new initiatives of the business.
It stands to reason that most expenditure when planning annually falls into these two types:
ongoing investment, sometimes described as the cost-base for a business
or Project-based investment.
There’s not an issue per se with planning investment this way - there are standalone investments that are finite in length and the spending is only for a limited period.
The assumption
Why Project-based funding is overused
Many organisations manage too much work with project funding even when some or all of the work is an ongoing commitment.
It may be a side-effect of their accounting practices. Overuse of Project-based funding might occur due to how the organisation determines what is to be part of the cost base and what is a temporary investment into the business. Many organisations struggle to map their future commitments to the current expenditures that create those commitments.
An example might be a project to establish a new service. The new service might increase the value of a product and maybe contribute to a higher price or result in more customers buying the product. Any new service will also add commitments to the cost base. Many organisations simply aggregate up all running costs and roll over the increased cost base at the end of each year. Another way the costs of running a service are quickly divorced from adding the service in the first place.
For many more, overuse may occur because this is how most people had experienced it or observed others manage at their previous workplaces and these patterns were repeated.
Another reason for using Project-based funding is when organisations attempt to create a forcing function to find efficiencies. By treating more work as project funding it forces an annual re-assessment of expenditure. By nature, this becomes a centralised mechanism for funding efficiency.
In practice, I question the efficacy, whilst the accounting may ensure the books are balanced and there is generally a positive growth trend and capital available to cover liabilities, it could only be assumed efficient if they started with the assumption that it was impossible to know many things that are known, elsewhere in the organisation.
It begs the question, for organisations that use project funding very broadly as an efficiency tool - is the effort and the overhead it introduces ever tested against the efficiencies found? Do the efficiencies way up against the cost of the side-effects project funding encourage that we will discuss later in this post?
The challenge with Project-based investment
Disconnection of spending from purpose
The business will want to account for each new investment and the associated returns on those investments. The distance between the cause and effect of different investments can differ greatly, some spending has an almost instantaneous return for instance some forms of advertising may translate into direct spending by customers and some spending such as training staff might contribute to improving competencies and capabilities which may or may not translate into business performance. Trying to reconcile these centrally and to the coarse granularity of projects can be a foolhardy endeavour.
An additional issue is that with Project-based funding, there also often follows fine-grained funding allocation. What I mean by this is that the more specific the funding allocation is, the less flexibility there is for allocating funds. These constraints may seem sensible, and in many cases, they are. There are alternative constraints that can be applied to attain the same or higher discipline and more alignment with the context in which the funds are being used and the attainment of value for the organisation.
Perverse incentives
Another insidious issue is budgets as incentives. Securing and holding budgets can become a political element in organisations especially where spending has become disconnected from its purpose. The variety of ways this can show up is likely a post in its own right so I suggest for now readers can share their own experiences in the comments.
The alternatives
The alternatives to this are various but fall roughly into these categories:
Improving the identification and traceability of funding and tracking ongoing cost commitments mapped to the value they support. This of course assumes that the value of different services is understood and that work and expenditure towards that value is also tracked.
More continuous approaches to planning such that the artifice that is a consequence of the annual planning process is reduced. This can be achieved by not allocating all spending upfront and allowing for the allocation of spending out of shared pools to support what is working and the most pressing needs.
Improving the identification and traceability of funding
For the first item, this can be improved by the executives involved in budget planning cooperating more closely and finding opportunities to align their spending and to work closely with the finance teams to track both the cost-base and reduce the overuse of Project-based funding or ensure that Project-based funding mapped to value-based investment which a continual relationship to the maintenance and operational costs associated.
One simple example you can observe in most businesses. People are hired and many of the costs associated with them are managed separately. Whilst some businesses may have some idea of the ‘on costs’ i.e. the cost of having someone onboard, much of the time these costs get separated.
The personal computers are managed under the Information Technology (IT) budget. The software licenses are managed under another sub-category of the IT budget. Other costs may sit with the Human Resources budget and so on. But these costs are a direct result of each new hire. And many of these costs in addition to the new salary are now ongoing commitments for the business.
And yet many businesses by having these directly connected costs tracked and managed independently create some bizarre situations where they are over-hiring and then underinvesting in how they support all staff by pretending the expenditures are unrelated.
An example that comes to mind is the many companies with large teams of software developers all laboring with underpowered machines which triple the time it takes to achieve anything. Surely a smaller team with machines that are fit-for-purpose is more efficient overall both from a cost perspective and impact?
We also found that with cloud-based investments such as Amazon Web Services and the like we were able to tag expenditure to particular services for which we understood the overall value. The IT and software development teams shared this information with our finance teams for easier forecasting and easier releasing of ongoing funding commitments if and when we retired services (which we did regularly - a topic of a future post).
More continuous approaches to planning
The very common challenge of businesses over-committing to spending at a rate they cannot achieve is also reduced. For instance, when departments do their planning separately and all commit to spending without knowing the full extent of demands and capacity consumed by the others it is often impossible for all spending to occur creating an environment of underspending but also one where other departments may have been unnecessarily constrained in planning even when that investment may have been the best additional investment for the organisation.
I found the Beyond Budgeting body of knowledge an excellent resource to draw inspiration from when adopting these concepts in a number of the places I have been a budget-holder.
After addressing the unchallenged assumption of hierarchical reporting structures and functional separation we organised product development into domains made up of multiple cross-functional teams which each managed several related services. To support efficient and regular budget decisions closer to where the need was we empowered leadership or committees to manage the domain’s budget. The allocation was based on forecasting that the domains managed in addition to some overall input from the product development leadership based on the organisational strategy and from continuous planning of the domain and the teams within the domain managed.
We worked with finance to change the available cost categories to map to each domain group (there were six and an extra one for leadership expenditure) rather than functional categories.
Expenditure was managed through trackers - simple logs of expenditure that were transparent, updated either automatically (such as output from SaaS billing and reporting) or as a natural course of spending (such as noting planned and actual spends on credit card spends such as acquiring online or in-person training, staff social events and so on). Most of these were simple spreadsheets with a list of intended spending and actual transactions - a row for each, the amount and who was responsible.
These proved far more accurate than the previous methods and soon IT and product development investment went from the least accurately forecast departments to the most accurate (i.e. well within +- 5%).
This was interesting to discover because cost variance is often the reason given for other approaches and yet an easier-to-manage and more empowering approach proved to exceed expectations by this measure!
Do you have examples where your organisation experiences significant friction in spending decisions due to the factors I’ve described? Has your organisation moved away from an annual planning approach where all spending has been fully allocated to one that is more continuous and retains a pool of unallocated spending so it can be responsive to conditions and what is working? Share your experiences in the comments.