How to Improve Financial Budgeting
Creating annual budgets is seen as an integral part of overseeing and evaluating the performance of a company. Budgets can cover anything from operating revenues and expenses, capital purchases, and financing (often times, all of the above). Like any other performance measuring tool, however, comparing results to your budget only helps if you have an effective, dynamic budgeting process in place. Placing too much importance on an ineffective budget will often do more harm than good. For this reason, your budgeting mantra should be “Do it right, or don’t do it at all”.
Avoid the SALY trap. An example of an ineffective budget strategy is to use the SALY (“Same As Last Year”) approach. While using last year’s expense or capital purchase numbers may provide a good starting point for your current year budget, other factors must be considered. Were there any unusual circumstances last year that caused an expense account to be abnormally high or low? Is there an increase or decrease in the cost of any of your key inputs? What about your insurance premiums (hint: they’re probably going up)? Is your production level increasing or decreasing? These are the types of questions that need to be asked when you set your current budget based on last year’s activity.
Make your budget flexible. Optimizing your use of financial budgets requires that budgets are allowed to shift during the year as market conditions (especially unpredictable ones) change. When unforeseeable circumstances cause a company to go over budget in a certain area, the company must decide whether it makes sense to reallocate resources or change course. Forces beyond the company’s control shouldn’t reflect negatively on managers who are responsible for the budget. Instead, they should be empowered to react to market changes so that they can take advantage of unexpected opportunities.
Maintain a long-term focus. Placing too much weight on a single year’s budget can often take focus off the bigger picture. For example, a situation may arise that allows the company to buy equipment at a discount that isn’t included in the current year’s capital purchase budget. Buying the equipment now may benefit the company in the long run, but it would mean going over budget this year. This is an example of both the importance of flexible budgeting and the complexity of using budgets as a way of measuring a company’s performance. Annual budgets may sometimes serve as an indicator of managerial performance, but long-term success of the business is the most important measure.
About the Author
Tim Peters is a consultant with Morrison, working primarily in our Business & Accounting Advisory practice. To get in touch with Tim, please find contact information for Morrison here.