United States

Budgeting methodologies


The need to budget in the proper context and link the annual operating and capital budgets to the club's overall strategic plan were addressed in last month's issue of eClub News. Failure to do so will almost certainly lead to an ineffective business plan. This month, attention is turned to several of the essential considerations surrounding the actual budget methodology routinely applied at private clubs.

An effective budget is typically comprised of four key ingredients:

  1. Realism. If a budget is to serve as a guide for activities in the coming year, it must be well-reasoned and reflect current conditions. Unsubstantiated revenue projections and wild guess cost estimates will render a budget ineffective as a management tool.
  2. Consistency. A budget must be consistent with short- and long-term strategic plans while also remaining aligned with the organization's mission.
  3. Flexibility. Budgets are based on a combination of facts and assumptions. If actual events and conditions vary from these assumptions, there must be opportunities to amend the budget to address revenue shortfalls, windfalls and unexpected expenses.
  4. Measurability. The basis on which the budget is created should be the same basis on which the books are maintained.

While some clubs allow committees to create the budgets that department heads and managers are then left to manage, this is not a practice to be endorsed. The professional management and staff who understand the granular composition of how the club functions must be empowered to run the mechanics of budget construction. The strategic plan is the guide for those professionals charged with aligning the realities of daily economic challenges with the hopes and desires of members at large. If the strategic plan is properly constructed with a realistic understanding of the cost of doing business and management is charged with delivering on that plan from an operational perspective, committee and board involvement in the construction of the budget should be minimal. While boards must approve the budget, copious amounts of committee and board time is a sure indicator that a strategy is missing and the governance model is flawed.

Methodologies: Incremental versus Zero-Based

Under the incremental approach, the foundation of the budget is the prior year's results. Managers start the process with last year's figures as a baseline and make adjustments based on anticipated needs and circumstances. Only expenditures over and above the baseline are required to be justified.

Clearly the advantages to this approach are that it is simple for department heads to understand, does not require much documentation or support and, relatively speaking, is not very time consuming.

Too often, however, one of the consistent results of this approach is that it promotes spending the budget as opposed to truly understanding and managing it. Over time, this can lead to a severely inflated budget as department heads simply spend money to ensure it is not removed from the budget for the subsequent year. This has also led in some cases to the tricky considerations about how to handle large budget surpluses at the end of the year if the club beats the budget by a significant amount. Arguably, it opens the door for members to charge that either the budget was flawed or that the club has overcharged them and they should receive refund. Neither scenario suggests good news for leadership and management.

Under the zero-based approach, the budget is created from the ground up or a base of $0. Historical results are still used but only as a guideline, not as the foundation of the budget. This is the fundamental difference between the two concepts.

Zero-based budgeting requires the budget be stripped down to bare bones and built from best estimates of what the club anticipates doing in each of its functional areas during the year. This methodology demands that department heads and managers justify every expenditure included in the budget, as opposed to the incremental methodology where managers are only required to justify expenditures over and above the prior year's results.

When properly implemented, the zero-based approach is a significantly more valuable management tool than the incremental approach. It is designed to identify and eliminate wasteful spending. Each expenditure is required to be justified and, if it is not adequately explained and supported, it should be removed from the budget. Arguably, zero-based budgeting provides a more efficient allocation of resources based on needs and benefits. One club executive who has been successfully transitioning his property to the zero-based approach over the last few years is always eager to discuss the improvements the new approach has brought to his club. Mike Chaffee, assistant general manager at Hideaway Beach on Marco Island, Florida explains:

"We're analyzing what we're spending and where we're spending it to determine if the benefit justifies the investment. Because the zero-based budget demands greater thought and analysis by department heads, it effectively gives them more 'skin in the game.' Staff motivation is increased by creating greater ownership and responsibility in decision making. Those of us in management are faced with greater accountability and are challenged to think 'outside the box' to identify more cost effective ways to improve operations. We are not simply doing what was done in the past – and the members are benefiting from a more efficient allocation of dues and users fees.

"Overall the zero-based approach is an entirely different management philosophy or culture that we've been implementing over the past three years and we believe it has been the catalyst behind the club's recent success. Now, it's certainly a learning process that we'll all improve on as we gain experience and continue to better understand the intricacies of the operation."

Whether a club decides to use zero-based or incremental budgeting or some hybrid method, its budget must make sense, which means all assumptions must be rational and be able to withstand stress testing. Next month, this discussion will continue through an exploration of how this can be accomplished and whether the past is indeed a prologue.