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How HR Can Make Budgeting More Precise

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Oct 25, 2018

Our customers sometimes tell us the stories that led them to seek out a workforce intelligence solution. One such story clearly describes a core inefficiency that is common to many companies. At this company, the leadership team wanted to develop a new product line and asked finance if they could afford the startup costs. Finance’s response was that there was no money to spare. However, at the end of the fiscal year, finance reported what they saw as good news: they had found that there was significant under-spending in headcount-related expenses. This budget had gone unused and now appeared as extra profit — a surplus that would have been more than enough to fund the new product line.

The line executives were not happy: the company had delayed a new product line that could have been launched to generate new income. Due to the lack of accuracy in the workforce planning process, the business lost eight months of financial gains.

Why planners pad workforce budgets

Having an end-of-year surplus for unused headcount is quite common and happens as the result of planners both intentionally and unintentionally padding the budget.

  • Companies generally underestimate the amount of employee attrition that will occur during a given year. As a result, money is set aside for staff who will not remain with the organization for the entire year.
  • Companies are not very good at predicting the success of their hiring processes. The budget includes all headcount planned for the year, but virtually every company either underdelivers on hiring or hires later than planned.
  • Companies sometimes “lose track” of employees as they are transferring them between business units with different accounting systems. At any given time, there can be many employees who appear in the wrong department, causing budget problems for both the source and receiving organizations.
  • Companies simply do not have an accurate way to translate headcount into dollars. Instead, they use averages: average commissions, average performance bonuses, average pay increases, benefits and so on. Averages are based on backward-looking data and often inject budget variances that are unpredictable and hard to manage.

In net, it is not unusual to see a 1 or 2 point variance between the actual people expenses and the budget. Since no company can afford to go over budget, the buffer variance is built right into the plan.

The problem with budget padding

In the eyes of investors, every dollar that a business has access to should be working to produce optimal business outcomes. When companies set aside “just in case” buffer for headcount instead of using it to generate better outcomes for their shareholders, that money is wasted.

Some might argue that there is a benefit to padding budgets, particularly at public companies. At the end of the year, if the company does not use the extra money set aside, the savings go directly to the bottom line. With increased profit margin — everything else being equal — the stock price goes up. The problem with this strategy is that the best a company can do is limited by the number of dollars it has saved. It is a risk-averse plan that minimizes a potential budget overrun, but forgoes potential gains that could far outweigh the cost savings.

What if, instead, a company could confidently spend that 1-2% buffer on better product, sales, marketing, or customer service? Could such investment improve the bottom line more than the underspent budget? If the company’s shareholders have not yet asked that question, they should.

What can HR do?

When done optimally, workforce planning is a collaborative, bottom-up effort between HR, operations, and finance. Operations uses its business expertise to create a workforce plan that outlines what positions are required to support every function in the organization, and HR builds predictive scenarios that lay out the availability and cost of people — both current employees and new recruits needed to support turnover or growth. Finance then takes that plan and translates it into accurate costs using HR’s total cost of workforce algorithms.

There are two common barriers to this scenario:

  • First, most HR teams do not have an accurate way of predicting employee attrition and hiring success.
  • Second, and perhaps more importantly, when it comes to setting budgets, finance is in charge. Finance is the group that ultimately determines how much money is available for operations and tells the organization to make that budget work.

Most workforce plans are created top down using last year’s averages, not bottom-up based on predictive algorithms and costs. But finance planners do not have insight into workforce dynamics, so when they create their top-down budget, they do not account for a variety of factors, such as seasonality, real cost of replacing attrition, benefits costs, trends in hiring and firing, and costs for relocation and recruitment.

HR, on the other hand, can create workforce plans that are much more detailed, pulling together not only salary and bonus data from the HRMS, but also broader workforce data from recruiting, facilities, contingent labor, payroll, and other people-related systems. Using workforce intelligence technology, HR can accurately forecast the total cost of workforce, clarify the costs of different workforce options, develop accurate hiring requirements based on historic turnover rates and seasonality, perform cohort analysis to understand probable behavior of different groups of employees, and model and compare workforce scenarios based on different assumptions to optimize costs.

To properly fulfill its strategic mandate, HR needs to rapidly build credibility and trust with finance. With the right workforce planning tools, HR can compare predictive plan scenarios to actual performance for previous business cycles, and prove the accuracy of the predictions. An option is to run a parallel planning cycle for a year and compare the results. With this data in hand, HR will be able to convince finance and operations that they can help to create a more accurate picture of the people side of the business and allow the planners to optimize their budgets.

With workforce costs taking up the lion’s share of expenses for most organizations, it is never too soon to start predicting headcount costs more accurately, reducing unproductive budget buffers and as a result delivering more value to stakeholders.

This article originally appeared on the Visier blog.