Why Do We Budget, and Do Budgets Make Good Plans?

Why Do We Budget, and Do Budgets Make Good Plans?

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Last week I asked the question "What is Budgeting?". This week we are going to dive into why Businesses Budget and if the Traditional Corporate Budget accomplishes what it sets out to do.

Why Do Businesses Budget?

If you do a quick Google search the above, you get the following reasons for businesses to budget.

  • Planning
  • Control
  • Performance Evaluation

The question business leaders fail to ask is, does a budget successfully serve these purposes?

In most organizations, large and small, they implement a type of process improvement protocol for their business. But for reasons unknown finance is exempt for this protocol.

Even with very seasoned CFOs, the finance department is sacred, or set apart from regular protocols. They are rarely given meaningful metrics to track their performance, and when questioned about their inefficiencies they often give blanket excuses and/0r shift blame to other departments.

Budgets are a great example of this. Budgets are often created and updated without knowing reasons for doing so. Today we are going to look at one area where budgets are supposed to provide value and evaluate whether or not they do.

Planning

My business and residence is located in the "Bible-belt". Because of this business owners like to backup what they do with the Bible. For budgeting, they often quote Jesus (Luke 14:28 NLT) 

“But don’t begin until you count the cost. For who would begin construction of a building without first calculating the cost to see if there is enough money to finish it?"

This quote is often used as an example of why budgeting is important. You don't want to look foolish by starting something and not be able to finish it. I agree with this statement and observation. However, this quote doesn't state the need to have a detailed plan of every single expense you have and follow that plan until the end. It does obviously says you should weigh the risk. If you have $50,000 and desire to build a house that would cost $100,000, don't do it. But nowhere does this quote say that you should have set in stone where every penny of that $50,000 should go before you start a project.

What is the purpose of planning at an organizational level? Planning is a way for an organization to weigh risks and help focus the organization's vision. 

There should be different levels of planning. Executive-level planning should be focused on what it looks like for the organization at a 10,000-feet level to achieve the organizational vision. The Executive-level should be looking at the overall picture from above not digging into the specific details of the plan. It should envision its teams and let them plan the execution of those details because they have the relevant knowledge and talent to do so.

Conclusion

Traditional budgeting fails at the planning purpose because it is too detailed and time-consuming. By the time it is finished everyone has budget fatigue and agrees to the terms, so they don't have to go through another budget revision. At that point, weighing the risk takes a back seat. The budget morphs into a crystal ball of how the goals will be achieved instead of if they are even reasonable. 

Planning needs to be done on a need-by-need basis. It should be done at the appropriate level and in the appropriate detail.  A budget will never be a crystal ball to tell you a goal is achievable or not. A budget should be like a scale where the perceived risks are outweighed by the estimated reward. Remember, if you can't easily track it, then the goal is probably not worth trying to achieve.

Additional Resources:
Companies Get Budgets All Wrong by The Wall Street Journal
How to Define Long Term Goals

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