The Importance of Budgeting
Updated: Nov 30, 2020
Many small businesses are resistant to the idea of formal budgeting. Some think it is overly rigid. Others say that it will hinder their ability to adapt dynamically to changing business conditions, which is what gives them an edge over their competition. Still others say it is impossible to budget because they just do not have a handle on what the next 12 months will look like.
These arguments represent a misunderstanding of the intent of the budgeting process and what a budget represents. A good budgeting process is about planning. It forces you to think through your business and how you will use resources to obtain your business objectives outlined in your strategic plan. It forces you to think carefully about realistic expectations for the future and to consider future performance instead of just past performance. A good budget should also push you, by setting challenging targets that can help motivate your organization. Furthermore, if done correctly, a budget will create a road map for you and your team. It will align your organization ensuring everyone is working towards a common goal.
Budgeting forces you to have debates during the planning process about what items are essential to achieving the organization's goals and what are simply nice to have. I always recommend that companies include a prioritized Wish and Cut list with their budget. This allows them to think through what items they will prioritize in the event they are performing better than expected, and it allows them to think through a contingency plan for if they perform worse than expected. This thought-out, forward-looking approach to budgeting creates alignment with the managers and owners of an organization. It also ensures the budget aligns with the strategy, since the strategic plan should be the primary factor in determining the essential aspects of the budget. A comprehensive budget also includes cash flow forecasts, helping you to plan for cyclical aspects of your business and adjust your spending or financing activities accordingly.
A good budgeting process includes input from all levels of the organization. This helps create buy-in and allows the organization to aggregate dispersed information from within. Care should be taken to ensure that managers at various levels of the organization are not building too much budgetary slack into their numbers. Budgetary slack is when an individual sets a target that they know will be easily achievable with minimal or no effort, and defeats the purpose of budgeting. An effective budget should provide a target that is achievable with hard work and motivates employees to achieve it. Incorporating employee input to the budgeting process encourages them take ownership of the targets.
Budgeting also allows for self-evaluation. If you do not compare your performance against set goals, you will not know if you are on target to reach your vision. You might be tempted to think that as long as you are growing, it shouldn't matter because growth is growth. However, companies that expand too rapidly with no plan on how to finance the growth or manage cash flows risk growing themselves into bankruptcy. A well thought out plan with clearly defined targets is a significantly better approach.
In summary, the benefits of a good budgets are clear:
They facilitate thoughtful planning
They create buy-in and motivation
They align the organization
They provide a road map for achieving the strategic plan
The final argument I commonly hear against having a budget is that it takes too much time or costs too much. The truth is budgeting is something organizations cannot afford to skip. They are an essential tool that your organization cannot do without.