Top 6 Budget Dos and Don’ts
Most companies begin the budget process for the next year around the end of the third quarter, which is the September/ October time frame for those with December/ January year ends.
Budgeting is viewed as a chore for many companies. Many small businesses do not budget and some that do approach the process with the enthusiasm they would have for counting a jar of beans. Even large companies struggle with how to make the budget process more accurate and more useful.
When done right, budgeting improves strategic decision-making. Here are our top six Budget Dos and Don’ts:
1. Treat the budget as a strategic decision-making process – Many companies treat budgets as a purely numeric exercise. Budgeting is too often viewed as something the finance team does that is disconnected from the overall strategy. But when done well, budgeting helps managers prioritize both tactical and strategic options. No company has unlimited resources and even those that have substantial resources need to plan carefully to ensure that projects generate sufficient returns. (Otherwise, they will have fewer resources in the future). Budgeting helps a business lay out all the things they would like to accomplish and then prioritize those that they can accomplish in the next year.
2. Get the whole management team involved – Preparing a formal budget should be a collaborative process and is a great way to get the entire management team on the same page. For department managers, this is an opportunity to lobby for the initiatives that will move the needle for each department in the coming year. It is a chance for senior leadership to share what they are expecting from every department and for each department to discuss what resources are needed to accomplish those goals. In this way, managers can co-author their success. Many businesses use the budget to determine the breakpoint for bonus incentives, so having a strong budget is essential to individual employee success as well as that of the company overall.
3. Get granular – The more precise the budget is, the more accurate it will be. If there are underlying factors that drive a budget category, model them in detail. Applying a percentage increase to the prior year figure is rarely going to produce a strong budget. Budget by person, by hour, by business trip and (our favorite thing at Pro4ma) by store. Make sure to tie variable costs to the factors that drive them and lock fixed costs. This will allow management to better understand leverage points for profitability.
4. Be honest about current performance – The worst budgets ignore current performance and call for an inflection in trend (always more positive) due to external circumstances and easy comparisons (to current bad performance). The budget process should include an honest assessment of current trends and an evaluation of what types of strategies should be implemented in light of trends. In the best case, there will be specific strategies to either maintain or improve performance from current levels. However, at other times, it may be appropriate to reduce expenses and capital plans in light of a tough environment. Hope is not an effective budgeting strategy.
5. Evaluate performance versus budget regularly – One symptom of a business that doesn’t take budgeting seriously is infrequent tracking versus the budget. Typically, some departments will be over budget and others will be under budget. Management can often adjust plans as needed to make the budget with enough notice and regular analysis. This is particularly important if the budget requires a specific capital plan and/or if employee incentives are tied to the budget. At the end of the fiscal year, it will likely be too late to make adjustments to meet the budget.
6. Use the budget as a basis for the Long Range Plan – A budget can be a great first step to creating a long-range plan. Often times expenses and investments made in one year take several years to have a full impact on performance. Many businesses under-earn in the early years of inception or after a major investment push. In this case, a multi-year plan is needed to measure how long investments will take to generate a return. Once a company gets in the practice of creating a strong budget and using the budget as the first year of the long-range plan, the entire process becomes easier next year.
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