A Little Budgeting Goes a Long Way, but a Little Budget Doesn’t

I have been involved in budgeting in one way or another for over 25 years.  I have seen it done in huge companies (a giant aircraft manufacturer) and small companies (a start up biotech).  I have seen it done quickly, and I have seen it take an inordinate amount of time.  While many would consider budgeting to be a nuisance, I consider it to be necessary.  It is a road map of what your company is going to look like over the next twelve months.  Done correctly, it allows business owners time to manage cash, plan capital expenditures, and ensure raw materials are purchased in a timely manner.  If your budget includes a list of all your contractual obligations, it reminds you which agreements you want to carry forward, and which agreements you should terminate in the upcoming year.   By creating a budget, you will be forced to think about next year’s sales, what you want to do to reward employees, where opportunities for expense reduction exist, and a multitude of other positive things.

Complex Budgets Work for Complicated Businesses, Simple Budgets Work for Simple Ones

There are a million ways to budget.  I have seen budgets built from the ground up, starting with last year’s invoices.  I have seen budgets done in a single day using run rates from previous periods.  I have seen CFO’s dictate the annual budget for all departments, and I have seen budgets built all the way from the bottom up.   Every method has trade-offs.  I will talk about why I like or dislike a couple methods, and then I will tell you how I like to do it.  In some of the companies I was at, my manager liked the run rate method, and we created the budget in a very short time.  Using run rates means you figure out, what your average usage was over a certain previous period, by account and project it out for the next year.  Let’s say we were using the prior year’s run rates.  It isn’t a bad approach if you are looking for brevity, but it’s not going to work well if you are looking for accuracy in a complicated business model.  There are a couple of obvious reasons why using run rates is not necessarily the right approach.  First, if you have stock-piled inventories of raw materials, your supply budget contains over-estimated usage.  Second, your utility bills are not flat over the year, even though your monthly budget is. You may spend the entire year explaining why you didn’t follow the expense profile in the budget on a monthly basis.  In addition, management may look for specific detail during the year.  You will be unable to adequately explain variances based on the budgeting method selected.

Real Numbers Matter

In companies where “padding” the budget is allowed, it is difficult for upper management to adequately forecast cash requirements.  In addition, it reserves resources where they are not necessarily needed; perhaps limiting other projects that would help fuel the company’s growth.  To me, it is important that managers try to hit their budget as closely and as reasonably possible, but most budgets are wrong the minute they are printed.  I have seen inordinate amounts of effort go into flogging people who miss their budget, which ends up creating incentives for them to pad their budgets the next year.  On the other hand, I have been in companies where no attention was paid whatsoever to the departmental budget, making it impossible to accurately guess where the company would end the year financially.  Requiring real numbers from your employees allows you to better plan for the future.

The Process Matters

Here are some things I have seen used that make the budget process go smoother, and the resultant budget more meaningful:

Give guidance.  As leaders of your company, managers and employees at all levels are waiting for you to set the tone.  At budget time give them a set of guidelines or assumptions that outline your expectations for the forthcoming year.  If nothing else, you should provide a meaningful sales forecast and a list of priority projects for the year.

Make a calendar and stick to it.  In many cases the annual budget is officially kicked off, but no calendar provided.   Hand out calendars and notify people immediately if the deadlines move around by issuing a revised calendar.

Get your employees buy-in by having an official “Kick-Off.”  In a big company, this can be cumbersome, but I like to schedule kick-off meetings with managers and above so we can go through the assumptions, expectations, calendar, templates, and areas of particular importance with everyone that’s impacted. That way, I know we are all on the same page, and I am confident the process will be much smoother in the end.  I have all the templates and definitions ready before the meeting, and either hand them out then or email them to the group directly afterwards. Additionally, I’m always willing and available to help anyone at any level fill out their templates.  It takes more of my time up front, but it makes the process more successful all the way around. And all parties are now vested in the process.

Big Items Matter; focus most of your attention on them.  Ultimately, a budget is a best guess on any given day, but guessing about nickels and dimes is a fruitless endeavor.  In general, I like to worry about four things the most – headcount, capital expenditures, contractual commitments and outside contractors.  Each industry will have unique practices that make a couple of other things rank higher than the others.  For example, in a biotech that is conducting clinical trials, you will want to know how many patients are expected in the upcoming year and how much it costs to include a single patient in the trial.  Those costs can be considerable and should be accounted for as accurately as possible.  By being confident about annual expenditures on the 3-5 big ticket items at the top of your company’s list, you will improve the accuracy of your budget.

Be involved.  Don’t wait until the deadline comes to check in with people and make sure things are going smoothly.  When I have people reporting to me, I have them check in with each department manager once a week to make sure they are hitting their milestones.  If I don’t have people reporting to me, I do it myself.  Treat budget owners like customers, and the process will go better for everyone involved.  Be ready to help your customers, and the final product will be much more accurate and useful.

Have a review

Ask tough questions.  I like reviews after the submissions have been received.  Each department manager comes in front of at least the CFO and the Finance department, hopefully, a broader range of leaders, and presents their budget and supports their annual budget submission.  I find if people know they have to support their product, they will do a more thoughtful job of compiling their budget.  It also makes them more knowledgeable about variances as the year progresses.

Hire Good Help

Have one or more great finance analyst working with you.  Nothing makes budgeting easier than having great finance employees helping with the process.

Turn around the budget quickly

I have never met a CFO who wanted you to take your time and get back to them at your leisure with the results of the annual budget process.  We have a strict policy of turning around, at least the bottom line numbers, by noon the day after submissions are due. We know that if we give managers until “noon on September 22nd” it means we will be working until the wee hours to turn the budget quickly.  I never mind because, to me, it’s game day.  If the number is in the right range, the CFO can relax and worry about something else.  If it is out of range the CFO can be out solving problems early.  By the end of the second day you should have totals by account by department and a comparison to YTD, or last year total expenditures, or some other bench mark.  The full compilation and reporting process should take less than a week.  If reviews are scheduled, it is helpful to know in advance if you have any issues with a certain department’s budget request.

Communicate fully

Communicate throughout the entire process.  If you keep everyone in the loop, everyone from the CEO to the person compiling the budget, you will all be better able to meet each others’ needs, the budget will be more accurate, and the experience will go better and more smoothly for all involved. Your budget is your roadmap for your near future. Invest in it wisely.

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