Budgets are not crystal balls, but they can provide a glimpse into the future by estimating actions necessary to maintain or increase profits and avoid incurring debts. Budgets are the baseline for creating strategic key performance indicators (KPIs) for your business, determining staffing needs, and creating individual goals. A budget allows an organization's leadership to maintain control, but only if it is prepared correctly and reviewed periodically throughout the year.
The budget should be a roadmap for the coming year to steer everyone's decisions and guide the answers to the questions:
Building an effective budget begins with working on it before the year-end rush.
Building an effective budget begins with working on it significantly earlier than just before the year-end rush. To give yourself plenty of time to plan and research, start the budget process at the beginning of the fourth quarter--even earlier if possible. If you start early, you should be able to devote adequate time to this critical business process without getting bogged down in multiple year-end deadlines.
The business world moves fast, so it may be challenging to recall all the factors shaping the organization throughout the year. To capture this information, you and your team should identify issues that might impact the following year's budget. Document these matters in a "living notes" file to reference when creating the new budget. Over the course of the year, use this file to highlight events shaping operational and financial outcomes.
A budget should be a realistic picture of what you think the next year will look like based on the economy, legal environment, and other factors. To create an effective budget, look at expenses and revenue. Expense trends are generally easy to identify and can be used to predict future needs. However, revenue figures can be more complicated, since investors’ cash flow expectations often drive them.
The revenue piece of a budget takes time to build out because variables will change, and the past is not always the best indicator of future performance. For example, an important contract could be modified or lost--through no fault of anyone within the organization--resulting in a domino effect on revenue.
One approach to creating the revenue portion of the budget is to map out projects for the year, factor in the number of staff and their pay rates, and determine the gross profit per client.
Some organizations without a detailed budget struggle with working backward. Leadership will say, "add 10% to last year, and that will be our budget." The financial team must spread that 10% increase across all areas. After that, they try to tie the amounts to a KPI. It sounds like a logical process but lacks strategy and analysis.
This type of budget--based on guesswork or hope--is almost worthless. The obvious problem is insufficient information to determine whether an across-the-board increase is achievable. A less obvious issue is that the people who generate revenue will be less challenged to pursue growth beyond that arbitrary number--even if the opportunity exists. For example, if the projected revenue increase is set at 10% based on guesswork, then there is no incentive to earn more or grow beyond expectations. The most difficult issue is that employees accept this low target at the beginning of the year and never fully commit to meeting growth needs.
Getting buy-in for the budget can be challenging when its foundation isn't realistic. To get buy-in, you first need to get input. Determine exactly what drives revenue so you can adjust it for the following year. Start with individual units and feed the information upward. Obtain the data from the driver of revenue sources, even if the individual's compensation is not tied to the revenue. If the discussion begins with the driver of a revenue source, the conversation, and emerging budget, will be more accurate. When employees turn in numbers related to the following year, it's okay to change them. However, communicate why the change was made, so such decisions are understood.
Develop expectations before year-end to be presented to the stakeholders/ owner(s). Lead the conversation with stakeholders well in advance of budget deadlines. When presenting the final budget, explain its reasoning thoroughly so stakeholders can understand why the budget was established in a specific way.
Being prepared to change and adapt is crucial in today's economic environment.
Budgets are living documents! They are roadmaps, but if you realize you aren't going to make the budget for the year-end, you can adjust during the year. It's impossible to anticipate every event that might impact the budget. Being prepared to change and adapt is crucial in today's economic environment. When circumstances change your long-term revenue or expense expectations, be flexible and adjust the remainder of the year's budget accordingly. The budgeted income for the year might go up or down, but that flexibility will help cultivate a culture of success, higher morale, and, potentially, better employee retention. Keep these human factors in mind. People want to make or beat the budget (whether for performance reviews, bonuses, or internal competitions).
In many organizations, there must be a cultural shift to educate leaders that a budget is not set in stone. It is a living document that can be adjusted throughout the year in the face of economic realities. For example, if an organization uses vehicles to deliver goods, fuel price increases would negatively impact revenue unless the budget was adjusted accordingly.
A detailed budget should not penalize owners or companies for factors beyond their control. The more complex the revenue build for the budget, the easier it is to adjust the budget to account for specific changes. It is easy to remove or adapt areas in the budget rather than trying to reduce the whole budget by a specific percentage.
Budgets should be considered one of the organization's most critical reports and processes. Budgets can help you set goals, identify key performance indicators by department or employee, and make employees feel more involved in the organization's success. Contact us to discuss how to begin building your budget for stronger outcomes all year.