So, What is a Budget?

Originally Posted on February 2 2011, 3:19 PM

I’ve already discussed this from a different angle here and I've already outlined what a budget is not here. So let’s see what a budget is.

Wikipedia:  A budget (from old French bougette, purse) is a list of all planned expenses and revenues. It is a plan for saving and spending

Wikipedia again: a budget is an organizational plan stated in monetary terms

Garrison\Noreen\Brewer Managerial Accounting it’s a plan for the future

eHow A budget allows managers to estimate and properly manage resources.

Grinning Planet: "A budget is just a method of worrying before you spend money, as well as afterward."

So it appears that everyone can give a definition of budget, so I feel obliged to give mine.

The budget is the list of what you’re going to do in the future, expressed in measurable terms.

Every budget, to actually be of any use, should be rooted in the actual actions people do every day.

Classic sales example: a salesman made 458K$ sales last year selling widgets in a B2B market. As the widgets market is expanding at an expected 3% year, this year his budget will be 472K$. This is what is done by most companies, a rather pointless math exercise.

20953516-BudgetxBlog.png

Useful sales example: The salesman has 3 gold levels customer and a dozen economy level customers. Two of the gold level have already shared their purchasing plans (124k$ and 111k$ respectively) for the coming year, so what they’re going to buy is already known. The third is at a lower level of cooperation but the salesman knows that, having already bought blue widgets and green widgets, it will likely be up-sold with red widgets.
The smaller customers buy small quantities of various widgets through the year, so the budget will be based on previous years purchases (on average, they buy 11.3k$, with an expected 3% growth is 11.64$ ). Two customers, though, have been cut off from a crowded street by road works that are going to last for 3 months, so they’ll likely not buy anything for the first quarter (8.7k$ each). Another customer is likely to churn for a competitor, and the salesman will try to retain the customer offering some special conditions such a good discount (a 10% off to 10.5k$). At the same time, to compensate for the expected reduced volumes, the salesman is tasked to acquire three new average economy customers within the first half of the year (to simplify, let’s say half the average to 5.8k$ each).
So, the salesman, in the coming years must:

  • control that the purchasing plans for customer 1 and 2 are met
  • make sure that customer 3 keeps buying like previous year
  • sell the red widgets to customer 3
  • avoid a churn with special conditions
  • control that smaller customers buy regularly
  • find three new economy customers

This is a good, actionable, measurable, to do list, that, by the way, brings to a monetary result of 497k$, 5.2% better if the plain 3% rule was applied.

We could go on making assumptions on better and worst cases, breaking down to quarters or months and planning sales expenses but I think I made the point. This plan is designed according to the salesman’s angle and states clearly what needs to be done. The main goal is split into many sub-goals that make identifying potential issues easier.

From the aggregated sales plans, a detailed widget production plan will be derived, the widget cost will be estimated etc. etc. etc.

An entire master budget is a “book” that contains all the company’s budgets. It’s a controller’s job to collect and harmonize the budgets.
This is the reason why budgeted income statement, cash flow and balance sheet are the very last result of the budget process.

There are some interesting consequences that arise from this approach, and I’ll cover them in future posts (just to make an example, how does a top down approach will fit into this structure?).

There are also a lot of advantages in building a non financial, bottom up, budget (everyone is in charge of his own figures, all the targets are harmonized, changes are managed much more quickly etc.) and I’ll describe them in the future but now, I’d like to end with an anecdote.

Some years ago an old CEO, close to retirement, of company that was implementing a budgeting system, questioned about the specific goals of the project, replied to me:
“I know that my budgeting is done right when I keep seeing the budget book on my managers’ desk, and I see the pages getting worn and dirty”

Somehow, this is a measurable goal too.

Stay Tuned!

 

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5820 views and 4 responses

  • Feb 3 2011, 3:03 AM

    FlyingBinary (Twitter) responded:

    Love the debate and the blog.

    Given the dismal outcomes that almost always result from the budgetting process and the tighten the belts world we are now working in, it is a timely debate.

    My take on this is we would have nothing to lose in running with such an approach. Like yourselves we are in charge of our own destiny and are constantly challenging the paradigm.

    The majority of the business world is not in that enviable position however, the accountants are in control. So tracking actuals and viewing this method as a proof of concept would be a good approach. It would however mean keeping two sets of books!

    I'd be interested to know if you already have this in progress.

  • Feb 3 2011, 6:39 AM

    Lex Verbrugge responded:

    Although I fully support the approach of the detailed budget-book rather than the 'I can do the entire budget on the back of an enveloppe'-approach, it seems the latter is much more favored by higher management levels untill .... they run into problems (not making their budget) and want to know what went wrong. Then what ?

    Yes, I'm sure there will be lots to write about.

  • Feb 3 2011, 6:39 PM

    Julie Hunt responded:

    Augusto,
    Interesting series so far - looking forward to the next installments.
    Using the construct of 'budget' as a standard for all levels of accountability throughout an enterprise, has positive potential for introducing more reality - data - into financial management and company goals.
    Your example of changing sales forecasting to sales budget-creation attacks the issue that most sales team forecasts are notoriously inaccurate and useless. You have outlined a method that ties future performance to concrete data, and to metrics that can be tracked.
    I also like your notion of 'budgetary collaboration' where all the pieces synch up.

  • Feb 4 2011, 1:03 AM

    Augusto Albeghi responded:

    @Lex I've seen too many budgets, "drawn on the back of an envelope" ending up with disappointing outcomes. Nobody is really accountable for the numbers but the top brass wants the money.

    @Julie I've seen too many guesswork or too much "false science" on this subject. I've seen simple and reliable models like the one I sketched above to be much more aligned with reality and useful to control the actual operations.
    This has A LOT of implications, an I'll try to cover them in future posts.