One of the first management processes that many emerging growth companies try to institutionalize is budgeting. Budgeting is an essential building block of good management. It serves to control spending in line with a company’s operating and capital plans. It provides a framework to compare actual revenue, expense, and profit with the plan. Budgeting forces accommodation and agreement between top-down management goals and bottom-up feedback from managers and staff about what is actually feasible for the company to achieve. And lastly, it imparts a sense of discipline and order to the company’s operations.
However, as companies grow, the benefits expected from the budgeting process often turn out to be less than intended. The kind of promising growth companies that Newport Board Group serves, should consider how to avoid the following issues as their budgeting process matures.
5 Budgeting Mistakes to Avoid
1. Assumptions Become Stale
A budget reflects analysis and coordination at a particular point in time, typically months before the start of the period to which the budget applies. It incorporates assumptions about the business, its customers, and the competitive environment, that may become out of date almost as soon as they are created. The budget that is based on these assumptions is stale by the time it is completed.
2. Budget is Hard to Change
Why not simply revise the budget as often as needed in the course of the year to reflect changed market and internal realities? The problem is often that budget setting tends to be elaborate and time consuming. It involves negotiations and horse trading for scarce resources between the CEO or CFO and managers across the organization. Revising the budget requires reopening these inter-connected compromises, distracting attention and energy from running the organization. The result is that budgets tend to remain static. In a business world where successful companies are more nimble than their competitors, reacting quickly to fast changing market conditions is critical. A budget that is “set in stone” can make a company less agile.
3. Managers “Game” the Process
As companies grow, the budgeting process may tend to become politicized. Managers start to “game” the process. Managers who know they are going to be evaluated mostly on whether they “made their numbers” try to commit to minimal revenue and other performance goals while obtaining maximum resources for their department. Budgeting becomes an exercise in target minimization. This can constrain management to the point of misusing resources. In a company that is rigid about rewarding managers for coming in on budget, the unintended consequence may be to hinder its ability to meet customers’ needs.
4. Budgets are Backward-Looking
Budgets have a tendency to be based on the company’s past performance (i.e. last year’s numbers revenue and expense numbers, plus or minus an incremental factor). This locks in a backward-looking mindset, rather than encouraging people to take a fresh view each year at the company’s assumptions and the potential for innovation.
5. Hard to Track Actual Versus Budget
In many companies, budgets and transaction systems are not integrated. This makes it hard to look below actual results and understand the reasons why they deviate from what was foreseen in the budget.
In the next part of this article, I will explain some new approaches that can avoid these problems and make the budgeting process more valuable, including the concept of “just in time” budgeting.
About the Author
Mark Rosenman has deep experience developing processes, systems and content to create value from intellectual capital. Serving as the Chief Knowledge Officer at Tatum, he successfully drove strategies to develop, capture, share and deploy the knowledge and experience of the firm's professionals. Contact or learn more about Mark here.
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