Budgeting Basics – Part 1 of 2 – Get your mind right
“Budget season is the most wonderful time of the year” – No One Ever
As we begin to wrap up the year many businesses are bustling around their finance department, eagerly working together to put the perfect finishing touches on next year’s budget. Like a beautiful bow atop the gift that was this past year, the budget will surely win the deepest adoration of every member of the board, who will grant immediate and unanimous approval whilst simultaneously handing out the most egregious of year-end bonuses. Does this sound familiar? If so, are you hiring?
But seriously, budget season often represents the stressful climax of a company’s fiscal year, weighing most heavily on finance departments the world over. The worse off performance to budget was in the current year, the higher the stress load and the lesser the non-finance departmental support due to individuals strategically trying to distance themselves from implied ownership of the numbers. Does this sound familiar? If so, you are not alone, and like me you’ve probably realized that it doesn’t have to be this way. But how can companies change?
Why do we budget?
Sometimes taking a step back to reestablish some basic principles goes a long way to initiating change. Admitting there’s a problem and accepting that maybe, just maybe there are better ways of doing things is a start, but you need to have the right mindset. Why do you budget? Sounds simple enough, right? But everyone thinks about budgets differently, even within the same company. So, to start it might help to gain alignment on the purpose of the budget, which generally is as follows:
To plan ahead – “If you don’t know where you are going any road can take you there” – Lewis Carroll. There’s a reason most companies use the term budget and plan interchangeably, so it’s good to see the budget as a means of planning for the next steps your business will be taking in the coming year.
To set expectations – budgeting is an opportunity to level set with your organization and ensure expectations about future performance are transparent, quantifiable, and memorialized.
To test thinking – Everyone sees pieces of the business a little different, so budgeting is an exercise in letting resident experts weigh in and help contribute to the process
To identify key business drivers – All good budgets are going to be driver driven, and therefore being able to identify the key drivers in your business and set expectations around those and test scenarios should be a significant part of the budgeting process.
To use as a reference and refine understanding – the act of budgeting is establishing a reference point based on the collective understanding of the organization. Once assumptions are set and actuals start rolling in, you have the opportunity to refine your understanding over time.
To track performance against expectations – likely the most obvious “why” point, by memorializing your plan you provide yourself the opportunity to then measure future performance against expectations. Bonus points if you managed to budget at a granular enough level where you can clearly see which assumptions missed the mark and ultimately drove key variances.
Notice none of the why’s I’m leaning on here are to get people to sign up for something, assign ownership, or drive performance. Quite simply, the budget is a measuring stick that your organization crafts for the coming year and the point is really the ability to demonstrate how well you not only understand the drivers in your organization, but also your ability to use those drivers to push the company in the direction you’re trying to head. The budget is a reflection on your collective grasp of and control over these drivers. This does not mean ownership does not exist; it is created, not assigned.
Once there is general alignment around the “why”, you can begin to further bolster the corporate understanding on budgeting by reaching some agreements around the “what”.
What is a budget, and what is it not?
A budget is a lot of things to a lot of people. Even if you reach a sort of consensus around the why of budgeting, there will still be philosophies around just what the budget is supposed to represent. With this in mind it would be further to everyone’s benefit to buy-in on what exactly a budget is, just as well as what it is not.
A budget is:
An opportunity – yes, I’m one of those people who likes to frame “problems” as opportunities, and I stand behind that thinking as I’ve made a pretty good career from it. But in all seriousness, the budgeting process should be seen as an opportunity for organizational thought leaders to come together and build a plan that all stakeholders can buy-in on, and that doesn’t happen often during day-to-day operations.
A guide – the budget is a guide built around assumptions, so it should be understood, and expected, that as assumptions prove accurate or otherwise things will at some point begin to deviate from the original guide – and that is okay.
A target – the budget should represent something your organization wants to hit, and therefore success in hitting it means you’re in a desirable place.
A point-in-time reference – Things change, people change, organizations change. It needs to be understood that the budget is formed at a point-in-time, and as things evolve it is entirely possible it becomes less and less relevant as the year moves on. This opens the door to a discussion on forecasting, but I’ll save that for another time.
A team effort – granted, if you’re a sole proprietor forming a budget you may not have a team of people around you providing input, but the point here is that the budget should be a culmination of inputs from more than one source or person. You’re only as strong as your weakest link, so the more strong contributors you can reasonably involve likely the better the outcome.
A budget is not
A small undertaking – even creating a budget for a small organization should be given a level of respect for pursuing. A lot of thought, energy, and planning goes into budgeting and that is not to be taken lightly.
A set-in-stone obligation – we’ve called the budget a guide, and a target, but it is not to be confused with an obligation. Once the process is completed, it’s now on the business operators to execute and be evaluated against the target, not obliged to follow it if components of it fail to make sense in execution or timing. Like people who have blamed their GPS after driving their car into a ditch, at some point you need to look up at the road and ensure the path you’re on still makes sense and react accordingly while not blindly clinging to an outdated map.
A right – some people see budgeted resources and believe this is the key to buying assets or hiring headcount. The budget is not a blanket approval for some future action, rather as that guide we discussed previously would suggest, it shows you what triggers likely should occur in order to justify making the case for taking action. In fact, best practices in many organizations require that something be budgeted as checklist item one before even initiating the process of seeking ultimate approval, but certainly a broader business case still needs to be made. This could be an article in itself… perhaps it will be.
A one-and-done exercise – the benefit of having a budget is to then monitor how it stacks up to actual executed results. You do not put all the time and effort into building a budget just to set it on the shelf and carry on about your business. No, the budget approval really should be the starting gun firing so that it can be loaded into your model or financial system and ongoing variance reporting will ensue so you can continue to dial in your understanding of the business and be prepared for the inevitable return of budgeting season come next year.
A solo mission – I know for many a senior financial professional lucky enough to be working on a budget that it can sometimes feel like a hot potato that no one wants to catch, let alone hold on to for very long. But again, the less people involved in the process the less ownership, the less insight, and ultimately the less value it will provide in helping the organization plan and execute moving forward.
Leadership is the key
As you can probably tell, for this to work it requires leadership. Even if you don’t agree with everything I’ve said to this point or your organization handles things differently, I hope you will at least agree that in order to succeed in the budget setting process, at a minimum you need to have some form of buy-in around why you are doing it, and what it ultimately represents for the organization. This buy-in starts at the top, and if you cannot achieve this, sure, you might squeak out a budget. But the stakeholders will be distant, the input will be limited, and come January month end it will be apparent that your plan will do more to drive department heads into silos than to promote healthy conversation around how well your assumptions about the business are hitting the mark and what you can do to change it.
I've had the great privilege of participating in well-run budgeting processes, and some that were very poorly executed. It was actually in the poorly executed processes where I was able to refine my understanding by clearly identifying the pieces of the process that were disregarded or viewed as unnecessary by leadership, but which were absolutely essential in order to achieve success. Part 2 of this article will dig into the “how”, or some of the tactical planning your organization can do in order to have a successful budget season of your own.
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