I hate wasted time. How about you?
I always seem to have more things to do with my time than time to do them. I figure I could fill two or three lifetimes with what I would like to do—in business and for pleasure.
It is that time of year where every good company is supposed to be preparing a budget. But is a budget really necessary to be a good company?
In this post, I will explain when a budget is a waste of time, and when it is necessary.
When I use the term budget, I mean an income statement with estimates of revenue and expenses for each month in the next year.
This type of budget should translate your goals and expectations for next year into numbers. You use these numbers to plan investments in people, marketing and equipment and to see the return on those investments in terms of revenue or reduced expenses. This budget also serves as a scorecard or benchmark to hold people accountable for producing results. Simply put, a budget is a benchmark—but there are other benchmarks that can be equally valuable depending on your situation. Other benchmarks include comparing current year results to the prior year and comparing current year results to industry standards or benchmarks.
You can also budget cash flow and a balance sheet, but budgeting those areas is beyond the scope of this post.
When Budgets are a Waste of Time
As a business owner, you do not need a budget, as defined above, if your business meets one of the following conditions:
- You are an early stage company and do not have investors with deep pockets.
- You have not proven which actions generate revenue for your business. In other words, your revenue model is not fully defined yet. Therefore, revenue is not predictable.
- When outside factors are changing and having unpredictable effects on revenue and those factors are largely out of your control. Why spend time trying to predict the unpredictable? (If this situation is true for your company, you will need to focus on strategic planning, not budgeting. You will want to determine strategic changes to make so that you can have more control over the company’s future. You may also need some new people.)
In the situations above, you may want to forecast expenses three months into the future and monitor your cash flows closely. You will want also want to establish specific goals so that your team knows where to focus and can experience the thrill of victory.
If you are not confident about estimating revenue, this post will help you do it well.
When Budgets are Valuable
Budgets are most valuable when the following conditions are true:
- Revenue is reasonably predictable.
- Executives and managers want to lead or manage.
- The employees enjoy achieving and winning.
- The business has long term financial goals.
Budgets can help you and your management team identify the actions required to generate revenue. In a classic sense, there are actions your company takes to generate leads, additional actions to qualify those leads, further actions to get an opportunity to make a proposal, and finally, actions to close and get revenue. The revenue budget should be built by specifying the quantity of each of those actions. Specifying the quantity of those actions drives not only revenue, but also certain expenses. By specifying the quantity of those actions required to generate the budgeted revenue, you can be sure to budget sufficient expense to handle all of the actions. Budgeting revenue and the related expense in this fashion also provides the basis for reporting budget to actual results not just for revenue and expenses, but also for actions.
If you are planning significant additional investments in people, buildings, equipment, software, sales, marketing or other expenses designed to increase efficiency, then preparing a budget will help you schedule the investments as well as the expected gains from those investments. As a CFO (Chief Financial Officer), I insist that people who want to spend additional money quantify the amount and timing of the expected benefit. I cannot remember anyone being happy about being forced to make those commitments. On the other hand, the business owner was quite happy to receive those commitments and have them documented in the budget. In my experience, I have learned that the desire to win will kick in for many executives and managers and they will find a way to produce the promised results.
If cash resources are tight, then a budget is the first step in producing a cash forecast. Many times growth can kill a company. The budget, in combination with the cash forecast, can help ensure that you do not grow too fast. Obviously, you do not want to make investments designed to grow revenue faster than your business can afford to grow.
For most companies, revenue is constrained by people, manufacturing capacity or both. The budget helps determine whether the company has sufficient capacity to produce the revenue.
Budgets are a great tool for enabling employees, managers and executives to set goals and measure their success in achieving them. If there is no budget, often there is no clear measure of victory. The managers and executives that you want will have a strong desire to win. Reporting budget to actual results shows them the score. They will either be able to celebrate or know that they need to work harder to win. In this instance, the business owner or CEO is using data to motivate employees to action, saving the CEO valuable time.
Long-term financial goals are generally broken down into annual goals. If the company achieves the annual goals, then it can be sure it will achieve the annual goals. Budgets provide a means for measuring that achievement.
Do you want to get going on thinking about next year’s budget? Read this post about how to use your historical income statement to help you predict the future.
My next post will provide an easy and efficient process for you to follow in preparing a budget. That process will produce three valuable things for your company:
- A repeatable and efficient budget process.
- A series of spreadsheets that manage the data.
- Reporting templates to ensure accountability during the year.
After that post, I will write about creating a culture of accountability—something that can be a great byproduct of a good budgeting process.
Does your company do an annual budget? If no, what is the reason for not doing budgets? If yes, what do you like and dislike about your current budgeting process? Please comment below.