Five Steps to Set Stretch Targets for your Budgeting Process
by Michael Coveney, co-author of "Budgeting, Planning, and Forecasting in Uncertain Times"
A few days ago I was looking through some blogs on LinkedIn when I came across a comment that suggested the purpose of budgeting was to set stretch targets. A number of people seemed to support this idea, although I personally have to disagree for two key reasons.
What is a stretch target?
First of all, what is actually meant by a stretch target. This can differ depending on where you sit. As the budget holder of a sales division, this may mean setting sales targets that are higher than what would normally be expected. For production, this may mean producing more goods for less while marketing may see this as attracting more enquiries than last year.
Stretch targets are by definition, pushing the boundaries on what can be realistically achieved. And each has the increased potential to reduce organizational performance – the very opposite of what they were supposed to do. For example, if the increased production volume is not achieved but sales achieve their goal, then customers won’t get what they ordered in time. Similarly, if manufacturing achieve their goal but marketing falls short, then valuable resources will be tied up in stock. Both scenarios will adversely impact the company. In the first case it will be their reputation with customers, while the second will impact working capital. The end result of both will be to decrease profitability.
Who sets the stretch target?
The second reason is that stretch targets, when set in isolation to the manager appointed to deliver them, will be seen as ‘not my numbers’ and so there is no ownership to deliver them. I’m sure we have all been victim to a ‘top-down’ target that is divorced from any kind of justification other than someone senior wanted to ‘push us’ to achieve something greater. Rarely will this type of action be motivating and will more typically lead the manager to conclude that those above him do not understand the business. This in itself is an incentive to not achieve the goal.
Setting Stretch Targets
I don’t have a problem with stretch targets but they need to be set in a reasonable way. Budgeting is not the time or the place to do it. Instead, the following steps are required:
- First, you have to know what is ‘reasonable’. In my experience, this is the purpose of forecasting – to find out what is likely to be achieved if things carry on as they are. It’s important that the figures are based on reality and so must come from those who are directly responsible for how income is generated and where resources are spent.
- Next, you need to look at where the market is going and what the organisation could achieve if it ‘stretched’ itself. This is where stretch targets are set, based on a clear understanding of market forces.
- The third step is to look at what needs to change in current business processes to bridge the gap between the forecast and the target just set. Ie what processes need to be improved or discontinued, what new processes need to be introduced, and where would the resources they would consume come from. The input to these should come from operational staff to help with ownership of the targets.
- The fourth step is to assign resources – which for me is the purpose of the budget process. Budgets are set in two parts – the resources required to support ‘business as usual ‘, and the second is to assign resources to the change initiatives identified in the last step. For more detail on this see my previous blog on Continuous Budgeting.
- Finally, we need to monitor that the change initiatives are being implemented and are on target to deliver the stretch targets. Of course some will be working and others won’t be, so the aim here is to find out why and if necessary make changes.
Adopting these steps provides organisations with an environment where improved performance can be managed in a collaborative way, rather than relying on hope.