Why do I Need a Budget?

Originally posted on February 13 2011, 3:10 PM

There’s an easy objection to the approach described in the previous posts on the subject. I have received a few comments, all stating the same points.

Why, in an ever changing environment, should I need a budget? If I set a target, isn't it the guarantee that I’ll stop after reaching it? Even if I work along a budget, what should I do with opportunities?

This question is not as trivial as it may appear. There is an ongoing academic debate on the subject and there’s a school of management, the so called “lean management” that questions the whole idea of budget itself.

So, doubts are licit and deserve a reply.

Why, in an ever changing environment, should I need a budget? 

Because the only way to know where you’re going inside an hurricane is following a precise course. While the environment changes around you, you adapt to changes. To adapt to changes, you make a plan. The plan should be economically sustainable, so I’d rather call it a budget. At least a budget revision.
The budget is not a stone monolith and is subject to revisions, mainly because of external factors. If you do not make plans and simply react to impulses, you might be personally satisfied of being highly adaptable but the you might end up very far from your target.
Real Life Example:  A cosmetic company realized that a competing firm mounted a rather compelling campaign, absolutely unforeseen, based on gazebos and caravans parked downtown offering free skincare advice by experts. They reacted mounting, in a very short time , an even more compelling campaign that even got some attention from mainstream media. The competing campaign got lost in the clutter they generated with the emergency initiative. To achieve that, the company spent the money that seemed necessary, thus burning the reserves for the budgeted, seasonal, campaigns, that came out really modest. Overwhelming the competition affected two quarters of normal operations, leading to a mediocre economic result. If someone had  planned the operation in detail before diving deep into it, a better compromise could be achieved.

 

If I set a target, isn't it guaranteed that I’ll never do better?

The target acts as a ceiling only if there’s no incentive in doing better and it’s too easily attainable.

There should be no reward in falling short of the target, but there should be an increasing reward in going beyond it. With such an incentive, the achiever will likely not stop after having achieved the target.
Setting the target, anyway, is a science and an art as well. Ideally, there’s a leveled, average, performance that can lead to a result at the end of the period. The target should be set at that level, plus "somewhat". That something should be high enough not to be met by a statistic fluctuation but by doing something beyond the conventional.
A fundamental part of every target system are the rules to avoid cheating. The most efficient is the one that states “it is explicitly forbidden to cheat the system”. Do not make the system byzantine complex; there’s always going to be a way to game it. Just warn the people not to cheat.

Real Life Example: A large bank introduced an articulated system of targets and incentives. It was a step within the larger framework of an operations reorganization. The system penalized both under achievers, obviously, but also over achievers; according to the principle that not having foreseen the correct results harmed the bank anyway.
The obvious result was that everybody always met their targets exactly. I bet someone in the bank headquarter rejoiced because the budgeting, at last, was working.

Even if I work along a budget, what should I do with opportunities?

Simply seize them! Just be sure that they’re real opportunities. That is, before doing something different from planned, make an estimate of the impact on the budget. What might appear as an opportunity from your perspective, might be an issue for the rest of the company.
This is probably the most important task under the comptroller responsibility as she’s the only one to have a global perspective.

Real Life Example: In a consulting firm landed unexpectedly a large new customer. The customer's previous consultants run suddenly out of business because the founder died in a car accident and the heirs shut down the company. The firm was a well positioned alternative and a salesman seized the opportunity to put a foot in the door. The consulting firm's brass was electrified, the new customer was a very prestigious name in its sector and it appeared to be out of reach for years.
The whole company was overturned to meet brilliantly the new customer’s expectations.
No use to say, the existing customer base began to feel abandoned and drift away. What appeared to be an opportunity put the whole company at risk. It took years to recover.

 

I hope I have answered all the questions. Do you agree or not?