It’s that time of year again. The big companies started “doing it” awhile ago. Most smaller businesses are just getting started. Some will still be “doing it” in January and some others won’t even give “it” a try.
“It” is the annual budget. Not everybody who is “doing it” is enjoying it and few are benefiting from it as much as they should. Take a look at last year’s effort.
How frequently have you used it during the last nine months? Was it worth the effort that went into it? Has it helped you make better decisions during the last nine months? The answers to these questions will determine the level of enthusiasm for this year’s annual budget.
It doesn’t have to be that way.
Done properly, a budget will increase the quality of your life by adding an element of predictability to your business. It will provide an objective standard for communicating the plans around which meaningful organizational development can take place. Budgets provide a control mechanism for increasing profitability.
Budgeting often deteriorates into an accounting exercise rather than the management decision making process that it should be. Financial statement preparation is an accounting function. Budgeting is a part of management’s planning function and should involve all of those charged with implementing the plan.
For the budgeting process to be successful there are three important prerequisites. First, the process must have the support and active involvement of the top managers. Without that support, sufficient time and attention will not be dedicated to the process. Budgeting either be forgotten or soon become a burdensome administrative activity that has no positive impact.
Next, the budget must a constructive tool for improving the overall operation of the business. Deviations from the budget should only be a means of focusing management attention on areas that need improvement. Unfortunately, budget deviations often provide an opportunity to assess blame. Improper use of the budget as a control mechanism will result in dysfunctional organizational behavior such as “padding the budget” and internal bickering.
Finally, all operational managers responsible for implementing the budget must be involved in creating it. The budget needs to be built by those making the everyday decisions and then used by them when making those decisions. Budget discipline must be accepted at all organizational levels.
A budget typically begins with a forecast of sales that is followed by a series of operating budgets that are accumulated into a set of pro-forma (budgeted) financial statements. The sales forecast is important because it is the initial step in the budgeting process and many of the operating budgets are based on the projected sales level.
Accurately projecting sales is difficult because it involves both internal variables, items such as pricing and promotion, and external variables, items such as customer decisions, competition, and economic trends. Making important forecasts based on external factors can be particularly frustrating. While it will never be done with absolute accuracy, estimates need to be made. However inaccurate your sales forecast maybe, no one will be able to do it better than you and your sales staff, the people closest to the action.
Successful budgets don’t rely on a single approach to forecasting sales. They have forecasts based on several different information sources, customer inquiries, market share projections, recent trends, or competitive analysis, and then reconcile them into a consensus forecast.
Analyzing the internal factors that will effect the sales forecast should be an active process, not a passive one. The questions to ask are active, “what can we do differently, better, or more imaginatively to meet our sales objectives”, not passive,”what do we think our customers will buy from us this year.”
The close association between planning and budgeting has led to overlap and confusion of these two important management functions. Strategic planning often becomes an exercise in extended budgeting with an emphasis on numbers rather than the quality of the thought that supports those numbers.
Planning is the first and foremost function of a good management system. Budgeting is not planning, but it is an important part of planning.
In the beginning, most organizations run “by the seat of the pants” and do so fairly successfully. However, their potential is limited until such time as they develop a process that enables them to focus and control their activities. The more competitive the environment, the greater the need for planning and budgeting.