The art and science of budgeting

Quick question: What is it that every company is doing right now? If your answer is ‘digital transformation’, then you are probably right… But it’s a sure thing that they are also preparing their budgets.

 And it’s very challenging to bring the discipline of budgeting and performance management to a context in which a company has digital and non-digital objectives. How to plan revenues, how much resources to invest, and how to spend those resources become even more important and harder questions.

My team and I have just been through this process. Although we are used to it, it is never easy. Usually it involves long meetings with debates about priorities and many spreadsheets. But I believe that the biggest challenge is to connect this task with the company’s dream for the future – its vision and purpose.

A common mistake is to try and align 100% of ‘the dream’ with the budget. The first must be always a guiding star, a goal that inspires everyone over the long term, shared by the whole company. The second is an objective plan for improving results and, if possible, fulfilling this dream. Maybe your company’s dream is to double the number of clients but, considering the current growth rate and market realities, in your budget it might be best to target a 50% increase in clients, as an example.

If the budget always reflects the dream, there is a high chance that people will get frustrated or will start to disregard something that should be a source of inspiration. A good Dream, by its very definition, is something that is hard to achieve. When it comes to business, it may also depend on many factors beyond merely the team’s effort. On the other hand, the budget should not stop people from continually referring to the dream: what else could we be doing, or could be doing better, in order to double the number of clients? Is this even still possible? How? In every team I lead, I always set two references: our budget for the year and our Dream.

Based on my experience, I have created a framework that helps me every year to evaluate whether the budget we are presenting is reasonable. I consider there are five types of budget, which vary according to the level of challenge:

- The complacent budget: mediocre numbers that represent zero challenge for the team. Maybe this unit just gave up on its dream.

- The soft budget: a conservative estimate with little challenge for the team.

- The fair budget: a realistic estimate. The team knows there will be a lot of work to do but can imagine themselves reaching the goal. It should be uncomfortable but achievable.

- The dreamy budget: a very positive estimate with a significant challenge for the team with numbers that have rarely been reached in the past.

- The detached budget: an unrealistic estimate that no one believes is achievable – normally proposed by a less experienced leader that just wants to impress as a ‘big dreamer’.

My advice is that the budget should be set as close as possible to the idea of ‘fair’ above. It depends, of course, on the context of the company. If the business has had excellent results and is experiencing significant growth, the budget should be set somewhere between ‘fair’ and ‘dreamy’. If it has faced a difficult year or is already anticipating major challenges in the near future, the budget might be set between ‘soft’ and ‘fair’. This energizes the team so that people can refocus and change whatever needs to be changed in order to create the conditions needed to start growing again (see diagram below)

Do not allow soft budgets to become the norm. And when you do set a softer budget, send a clear message to everyone that it is not something they should get used to. Explain that a more conservative estimate will give time and resources for everyone to reinforce the foundations, get the results back on track, rebuild momentum and, in the following year, start battling to achieve more stretching goals that take you closer to the company’s dream. People that get used to soft budgets can rapidly become complacent and start celebrating easy results.

The complacency virus is a strong one. I have seen many teams present their budgets with a lot of drama, trying to protect themselves from challenges, only to pat each other on the back at the end of the year after having accomplished very few things.

At the same time, I see high-potential teams trying to manage expectations. They want to be bold with the budget but are uncertain about what they can really accomplish. Why not work with realistic but challenging estimates in the budget (between Fair and Dream) and leave the full boldness for the dream?

So, if you are putting together your budget, consider these ideas. It’s not mandatory to insert your dream into your budget and, most importantly, avoid being ‘detached’. Shoot for Fair and Challenging. Don’t ever be complacent, and always let people know that if the budget needs to be a little soft on a certain occasion, it is only a matter of time before it will go back to being more challenging and that it’s the team job to use the year as an opportunity to regain momentum.

But the most important tip: in your routine, keep focusing on achieving your dreams, because this is far more exciting than celebrating reaching any budget.