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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.

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 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.

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

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.

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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.

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 withoperations, 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.

About the Author

Shawn Capistrano

CFO & Advisory Services

Shawn has over 20 years’ experience as a senior Finance and Operations Expert for organizations ranging from start-ups to publicly traded companies and not-for-profits, across multiple industries, including companies such as EarthLink, Inc. and Activision, Inc.

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