Facebooktwitterpinterestlinkedinmail

One Big Budgeting Mistake You’re Probably Making

A budget-first mindset not only wastes time and resources but also often results in an unrealistic and/or inaccurate budget.

It’s a time-old Q4 tradition—lengthy planning cycles consisting of sitting down to tap out a budget, handing out spreadsheets to managers to show why they need money and where, deciding where should costs be cut, and determining where more money should be allocated.

After this budget is (finally) complete, many companies will also use the budget as a forecast for the year. However, this budget-first mindset not only wastes time and resources but also often results in an unrealistic and/or inaccurate budget.

Let’s take a moment and clarify definitions: A budget is a plan for the year, which doesn’t change. Actuals are compared to the budget to track performance against that plan.  A forecast is a forward-looking strategy that supports scenario planning to help identify the path from where you are to where you want to go. It is updated with actuals as the year progresses, along with updates to the future months as additional information becomes available or is refined. The forecast represents your most current, informed view of the future. Actuals should also be compared to the last version of the forecast to track whether you’re meeting expectations.

Why Your Company Shouldn’t have a “Budgeting First” Mindset

We have a lot of companies who turn to our outsourced CFO team when they’re in need of help for budgeting or cash flow. What we usually find is that rather than finances intentionally driving company goals, finances have become a barrier or speed bump in goal achievement.

When companies have a budget-first mindset, we see:

  • Long financial planning times (two to four months on average) that delay decision making
  • Budgets with no connection to the strategic goals for the year
  • Drivers and metrics that don’t align with long-term goals
  • Budgets that are unrealistic or inaccurate
  • Conservative estimates instead of realistic ones
  • The “letters to Santa” approach from managers who submit a “wish list”. The budget requests end up overinflated and then get cut during the  process, and then the cuts are used as an excuse for under-performance.

We’re not the only ones who’ve noticed companies need to rewire budgeting mindsets

In a recent study by PwC, they found that 69% of companies hoped to turn their financial focus toward improving budgeting, forecasting, and planning. In addition, 74% of finance departments hoped to improve decision support and business analysis in their company.

We find a lot of the struggle results from the mindset.

Traditionally, the mindset of budgeting is to contain costs. Off the record, budgeting is also used to set low expectations so that managers can exceed those expectations and get bigger bonuses (we’re looking at you, sales managers).*

*We’re actually not joking—in the same PwC study, they found that the majority of managers are conservative in their estimates, so they don’t inflate expectations.

Finance isn’t just about controlling costs and providing financial insights; it’s also necessary for driving business decisions and empowering a company’s ability to effectively and efficiently achieve goals.

The Big Picture: Instead of building a budget, companies should build an annual operating plan and use that plan to drive a budget and forecast

If companies focus on building an annual operating plan and using that plan to drive a budget and forecast (instead of the other way around), then they can define more actionable data that intentionally supports progress toward strategic company goals.

Here’s how to do it:

The first step of designing your annual operating plan is to decide on one to three strategic goals for the year. These goals should be specific, quantifiable, and should not exceed three at most (seriously!).

Next, determine what resources you will need to execute these goals. Some areas to consider:

  • Sales and marketing
  • Product development
  • Support
  • Resources (tools, outsourced resources, facilities, equipment, etc.)
  • Funding
  • Personnel (do you have the correct skill sets in-house? Need additional staff? Training?)

Finally, sit down and build a plan for the company is going to achieve these goals over the next 12 months. Account for all additional costs as well as projected profit and sales impacts. If something doesn’t support the achievement of the strategic goals, why is it included? Is there a valid justification for including it? If not, you need to have the hard conversation on whether or not it stays.

After you’ve designed your operating plan, you’ll find that most of your budget is complete. At the first of the year, take one copy of this budget and lock it away. You can use this to compare budget to actuals and track progress against your goals, and at the end of the year use it to inform your next year’s goals and expectations.

As the year progresses, update a second copy of the budget monthly or quarterly and you’ll have a rolling forecast

We’re a huge fan of rolling forecasts since they allow companies to look forward toward the coming months and make adjustments to their forecast to account for actuals and updated information that becomes available (e.g. did that new product take off far beyond expectations? Revise your outlook in the forecast for the remainder of the year to reflect it).

Instead of using an outdated budget to make financial decisions, this allows the executive team to use the most up-to-date, goal-oriented information to make strategic decisions.

The result is:

  • Less wasted spend and more accurate budgets/forecasts
  • Financial decisions that align with long-term company goals
  • Faster, more sustainable achievement of goals
  • Finances that support operations rather than suppressing them
  • And most importantly, a defined set of goals with a plan to achieve them, with a way to track progress against the plan

Final Thoughts

One of the worst things an executive can say is that they only need enough financial information to know what’s going on in the company. Finance isn’t just about reporting historical data; it should work for and with operations, supporting progress toward company goals.

By switching from a budget-first mindset to an annual operating plan mindset, executives and managers can make decisions that support operations and provide them with the right information to take action to achieve those strategic goals.

How Can We Help?

Would you like help transitioning your company from a budget-first mindset to a forward-looking, strategic mindset? Contact Preferred CFO for a free consultation with one of our expert CFOs.

You may also be interested in…

Managing Business Expenses in Inflationary Times

Managing Business Expenses in Inflationary Times

Inflationary times pose challenges, but with strategic expense management, businesses can navigate these periods successfully. By understanding the impact of inflation, implementing cost-cutting measures, engaging in strategic financial planning, and embracing sustainable practices, businesses can not only weather economic storms but also position themselves for long-term success.

read more
Why You Need Fractional CFO Services in 2024

Why You Need Fractional CFO Services in 2024

Why You Need Fractional CFO Services in 2024  In the fast-paced, ever-evolving business environment of 2024, companies across the globe are increasingly recognizing the need for innovative financial management strategies. The US and global economy is in a state of...

read more
20 Things Every Entrepreneur Needs to Know about Accounting

20 Things Every Entrepreneur Needs to Know about Accounting

While entrepreneurs don’t need to become professional accountants, having a solid foundation in accounting principles and practices will enable them to make informed financial decisions, communicate effectively with financial professionals, and ensure the financial health and success of their business.

read more
Top Human Resources Strategies for 2024

Top Human Resources Strategies for 2024

Welcome to our insightful webinar featuring Tom Applegarth, a renowned expert in the field of Human Resources and our expert Outsourced Human Resources Manager at Preferred CFO. In this webinar, Tom shared with us his valuable strategies and insights for HR success in...

read more
Is it Time to Sell Your Business?

Is it Time to Sell Your Business?

Deciding whether and when to sell your business is a significant and complex decision that should not be undertaken lightly. If the timing is right, the offer is right, and the necessary work is done correctly, selling your business can be highly beneficial. However,...

read more
Understanding Organic Growth vs Inorganic Growth

Understanding Organic Growth vs Inorganic Growth

Business growth requires both organic and inorganic growth. Each method carries its own set of advantages, challenges, and implications for the trajectory of a company. Whether you are a startup or established enterprise, understanding the dynamics of organic and...

read more
Management Development Unlocked Podcast

Management Development Unlocked Podcast

This episode of Management Development Unlocked marks the 50th episode! Eric’s guest is Tom Applegarth. Tom’s entire career has been spent in human resources at multiple companies, both big and small. Today, he is the Vice President of Human Resources for Preferred...

read more
Facebooktwitterpinterestlinkedinmail