Common Misunderstandings about Budget

Originally posted January 28 2011, 1:41 PM

Every company makes a budget. It might be a short informal brainstorming or a long, heavy and formal process, it may be explicit or implicit, but everyone makes a budget.
Unluckily, few make a useful budget. It often remains a generic guideline or an empty math exercise that sets detailed goals, often unattainable, that nobody really pursues.

As I’m used to do, I start by telling what a budget is not.

It is not a forecast. That is, nobody has a working crystal ball so forecasts are prone to errors. Forecasting sales and expenses on a statistic basis might be a good starting point, but nothing more.

It is not a basic math exercise. Adding percentages to last year figures is not budgeting, it’s 5th grader’s arithmetic. It’s simply no use.

It’s not guesswork. While manager’s experience is an invaluable guideline, asking them to guess next year’s figures is still a futile exercise.

It’s not preparing a budget income statement, balance sheet and cash flow statement. These 3 documents are the final outcome of the budget process; they’re a result, not the starting point.

It’s not a budget P&L statement. A sound budget, sliceable, P&L statement is, once more, an outcome of the budget process, not the starting point.

It’s not about sales. At  least, not only. A complete budget includes a lot of topics. Sales are only those to be prepared first.

It’s not about costs. As above, costs are only one of the topics. They’re often the most intricate, even from the point of  view of the math involved , but they’re only an element among the others.

It’s not about investments. Once again, investments are only one of the topics to be covered while preparing a budget.

It’s not setting guidelines. Strategic planning sets guidelines, the budget defines other issues.

At this point I’m sure that you’re craving for a budget definition. You’ve been told about what’s not, now you want to know what is it, right?

Well, as I’m well known sadist, I’m not telling it now. You have to wait for a later post.

Take care.

Feel free to insult me, I understand.

 

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budgetingplanning

4935 views and 5 responses

  • Jan 29 2011, 4:43 PM

    Geoffrey Kearney responded:

    Direct and to the point. Well written!

  • Jan 30 2011, 1:20 AM

    Phil Simon (Facebook) responded:

    I find it interesting when big companies claim that they have "no budget" for something because everything is planned out until the end of the fiscal year. The same holds true for departments.

    I just don't buy it.

    Are you telling me that a company/dept doesn't have $500 in the event that something presents itself?

    "We don't have the budget" is just an excuse. People who really want to be great find ways to get things done. They don't rely upon facile excuses.

  • Jan 30 2011, 3:29 AM

    Augusto Albeghi responded:

    @Phil I'll cover that in a later topic, when I'll be talking about revisions, so stay tuned!

  • Jan 30 2011, 4:50 PM

    Hiran de Silva responded:

    Ok, I'm cheating a bit because this was my field in corporate life for a good 15 years.

    What a budget should be is ... is a set of inter-related numbers that coherently describe the business plan for the coming (say) year. Not just sales and costs as just numbers entered in a row, but amounts that fit together properly (coherently). For example, you can only sell the quantity of product you have, made, or bought (sales qty needs to be > stock available). You can only deploy the human resources you have. eg. in a consultancy you cannot show income for 150 people when you have only got 80 people on board, also need to make allowance for % utilisation/downtime etc. A budget is best designed as a flexible model that has the main drivers - eg. if demand goes up you need to increase production. Why? because many more people want to buy your product and you will lose opportunity if you don' t have any to sell them. (Phil Simon's point - if by spending £100,000 that's not in the budget you can gain £175,000 of additional sales you will lose £75,000 if you say 'there's no budget').

    But most companies have static budgets 'cos its easier to understand. Totally useless except in the simplest of cases.

    My old boss (famous and big) wasn't interested in whether budgets were kept to. He wanted to know whether we made what we 'should have' made in a particular month. Whether we took all available opportunities. So his interest was not about what was IN the budget but what was NOT ... but now presented itself as an opportunity. That's why he'e so successful ...

  • Jan 30 2011, 4:52 PM

    Hiran de Silva responded:

    Sorry, duff link above