To many companies, a budget is often associated with long hours of work that yields spreadsheets of inaccuracies that constantly requires explanations to the users. Sadly, this is a picture of daily reality for many finance personnel.
A budget is meant to help managers/decision makers achieve their objectives but because of how budgets are prepared, they often work against the company objectives.
There are two primary functions of a budget – planning and financial control. Some argue that a finance manager or CFO must choose that which is most important to him or her – planning or financial control.
It is worth noting that regardless of what is most important to you as a decision maker, a budget is not the same as a forecast.
A forecast is only a projection or guess of what you think might happen whereas a budget is a helpful tool for you in dealing with potential problems or scenarios. It is not just a guess but a written commitment to your guess in order to steer the company towards your desired outcome.
There are of course different definitions of budgets but for the purpose of this article – budget here refers to a company´s operating budget e.g. revenue and expenses.
As mentioned earlier, preparing a budget is rather tricky and there are several ways of doing it. Each has its advantages and disadvantages.
We have listed below the 5 questions that you should answer if you want to use budget as a means of financial control in your organization.
- Should we do Rolling Budgets or should we do Budget Revision?
The first thing you should consider is whether you want your budget to look ahead 9 to 12 months or if you want to revise your budget when the need arises.
A rolling forecast is good because of its coverage which means you can make necessary adjustments to your production and inventories in time before your delay costs your company money. However, a rolling forecast requires significant staff time to prepare and usually disrupts operations 4x annually because of the need to plan.
On the other hand, a budget revision presents to you a situation where your company can decide to revise the annual budget within the fiscal year depending upon changes in the market conditions. Revisions are more accurate because you always use your most recent information but the downside is that it cannot accurately measure performance or a budget cannot be used to evaluate your managers.
- Should we use Flexible Budget or fixed budget?
The next question to answer is whether or not you want a fixed or flexible budget.
A flexible budget is very good for performance analysis as it can look at the variance effects of actual and estimated costs and revenues. This is especially useful for companies that operate in highly uncertain climates because flexible budgets can adapt to ever changing factors.
- Should the bonuses be based on budgets?
Another question worth pondering over is whether or not you should attach bonuses to budgets.
While many companies use budgets to evaluate their managers´ performance because it drives managers to perform better, there is also a downside to it. Attaching bonuses to budgets can lead to budget games within the organization whereby they try to influence the budgeting process by making sure that their budgets are high and their targets are low.
If you really want to attain financial control within the company, rewarding your managers through their budgets can be appropriate but you must also be sure that you have a plan on how to detect and deter budget games that your managers will employ. Make sure you are aware of the activities being budgeted and be wary of these games they are playing so you can remedy it as soon as you detect it. Also make sure you know the territory of each manager well.
- Should we use Budget as a tool for Performance Evaluation?
If you want to use your budgets as a tool to evaluate performance, you need to think about where you want to focus: Final net profit or revenues and expenses for respective business units.
Regardless of which type of profit you want to use to evaluate performance against, make sure that you have a good control system for reinforcing the importance of that particular measuring tool and make sure your incentives reflect the economic capability of your organization. This becomes even more important for those managers that are responsible for larger/more critical business units.
One of the good things that come out of using bottom-line profit in evaluating department or product managers is that they tend to scrutinize corporate expenses more which helps in controlling corporate spending.
- How much stretch should we allow in our budgets?
Deciding how tight your budget should be is also an important consideration. Setting a goal that is slightly beyond expectation usually leads to individuals accepting it and working hard to achieve it. However, when the goals are set unrealistically high then it backfires because your workers will reject it and they will be demotivated to perform well.
Therefore, in budgeting it is good that you think about how tight you want to set your budget in a way that still motivates your workers. Of course, this is easier said than done. This is precisely why there is wisdom in having managers who are knowledgeable about operations so that a realistic budget can be set for the front liners.
On the other hand, once you keep adjusting your budget until it reaches the profit top that you desire, it can also be counterproductive as it fosters mistrust and insecurity among your managers.
Improving Budgeting to Attain Better Financial Control
Budgets once prepared, implemented, and analyzed well can truly help the company achieve tighter financial control and achieve its company objectives.
That being said, there are many ways by which budgeting in many companies today can be improved. For example, budgeting in spreadsheets manually is something that should be shifted away from. There is wisdom in automation of certain tasks so that more time can be spent in analyzing and less time spent in mundane tasks such as fixing of broken links and macros.
If your priority is to obtain tighter financial control in your organization using budgets, talk to one of our consultants and see how Performance Canvas Financials can help. Visit www.performancecanvas.com for more information or email firstname.lastname@example.org.
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