Do you ever feel like your annual budgeting process isn’t working the way it’s meant to?
Or do you feel like there’s no point to budgeting because it always seems to fall apart before the end of the first quarter?
You’re not alone in these struggles. Failed budgets are a common problem, no matter what kind of business you’re running.
Let’s take a closer look at some of the common challenges and pitfalls that often result in failed budgets, then consider some potential solutions or alternative ways of approaching the budgeting process so you can lead your company to success.
Five Common Budgeting Mistakes and Pitfalls
Budgets are an essential part of the planning process. Unfortunately, many leaders fall into the same traps year in and year out.
The first step towards improving your budgeting process is to understand where you might be going wrong, as well as some of the common problems associated with ineffective budgeting.
1. The Past Does Not Equal the Future
One of the most common budgeting errors, and one of the first things that most budgeting detractors like to point out, is that budgets are often predicated on what happened last year. Unfortunately, in today’s dynamic environment, what happened last year can rarely be used as a basis for predicting or planning for next year.
Basing next year’s budget on last year’s performance can also have the effect of limiting your results simply because “that happened last year”.
Does that really make sense? If you only saw 5% growth last year, does that mean you should be predicting similar numbers for the next?
Can you see the potential limitations you are inadvertently placing on your team by using historical numbers?
I’m not suggesting that those numbers are irrelevant, but simply that what has already happened may not happen again—especially if you make strategic changes.
2. Pulling Predictions Out of a Hat
Even worse than a budget that is based strictly on last year’s performance is one which has no basis at all.
A common budgeting error is to make predictions without going through the process of testing and gathering evidence. For example, coming up with arbitrary numbers. “Based on last year’s sales, we should be able to grow 15% next year.”
It’s important to take the time to come up with verifiable numbers. Don’t make the mistake of basing your budget on assumptions. If you do, the results will rarely work out in your favor.
3. Getting Off Course
The entrepreneurial mind has many strengths, one of which is the ability to generate new ideas. But this strength can also be one of the biggest obstacles when it comes to implementing a successful budgeting process.
Because we have so many ideas, we want to start lots of projects to grow our business. As a result, we can fall into another trap of unreal expectations and trying to do too much.
As the CEO or leader of your organization, it’s important to have a process in place to ensure that you remain objective, test your assumptions, and choose which ideas to say “no” to… or at least “not right now.”
4. Maintaining the Status Quo
There is a distinct difference between planning to maintain the status quo and planning for success.
Most budgets are about setting safe, reasonable targets that everyone on the team feels comfortable with—especially when budgeting precedes strategy (more on this later). Success or failure is often measured based upon how close your team comes to hitting their projected numbers.
While it’s important to set realistic goals, it’s also important to set goals that require you to stretch the comfort zone of both you and your team. All too often budgets mean having a conversation about safe and conservative limits instead of reaching for a target that may have felt unachievable last year. It’s important to make sure that your budgeting process is about making smart, calculated decisions—not limiting ones.
5. Budgets are Often Too Rigid
Failed budgets often present themselves as rigid plans that leave no room for change or improvement. This presents two key problems:
First, in a global marketplace, it’s not realistic to expect that the budget you have in place on January 1 will still be accurate and relevant on June 30. In today’s dynamic environment, the odds are too high that a change will occur at some point during the next 12 months. Very rarely can budgets predict or account for these fluid changes.
Second, a rigid plan fails to encourage an environment in which continuous improvement or lean is a leading principle. If people become fixated on a budgetary goal, it’s less likely that they look for areas of potential improvement.
How to Create Budgets That Lead to Success
Begin the budgeting process with an open mind—consider all possibilities, challenge assumptions, and encourage input and feedback from your team. Here are some specific strategies worth implementing.
Strategy First, Budget Second
Too many companies start with the budgeting process and then make sure their strategic plan fits into that budget. Not only is that process backwards, but it’s also highly unlikely that taking this approach will result in initiatives that propel your company forward.
Your team, and people in general, inherently want to perform at their best. By placing strategic planning before the budgeting process, you open your team and your organization up to exploring new possibilities.
Think about the future and consider the results of asking the following questions:
- Regardless of the costs involved and current capabilities, what’s the sales and profit opportunity of implementing a specific strategy?
- Can you estimate 1st and 2nd year sales and costs associated with that strategy?
- What are the incremental margins that will be generated?
After you come up with 2 or 3 really good strategies that the group believes will move the company closer to its ultimate goal and vision, then add this information into your budget.
Model and Test New Strategies
With your team thinking outside of the box, there is a good chance that your strategic process will generate some good ideas. But, there’s also the possibility of some bad ideas too. That’s why it’s important to model and test any new strategies or assumptions. Ensure that you can build a budget around them that makes sense financially.
Consider the following:
- How much will the implementation of a new initiative or strategy cost?
- How much revenue will it produce?
- Most importantly, is the initiative profitable enough to justify the required time and effort?
- Are you making any decisions based upon assumptions or feelings?
- When (not if) the variables change, what will the impact be on your overall budget?
Review and Reassess
You’d probably agree that it’s important to review and assess employees, processes, and strategies. But, it’s also important to review and assess your budget. On a quarterly basis, assemble your team for an open discussion about what’s working and what isn’t.
Where do they anticipate adjustments will need to be made going forward?
Some specific considerations include:
- Comparing cost and revenue projections to actual results.
- Are revenues meeting projections?
- Are expenses over or under budget?
- Are there opportunities to improve or make adjustments?
The Key to Success
The single largest factor that will contribute towards your company successfully meeting its budget lies in leadership remaining open-minded to the process. If what you’ve been doing in the past hasn’t worked, i.e. not meeting budgets, is it time to consider changing the way you do things?
Once you are open to a new process, open and productive discussions, accurate models, forward-thinking strategies, and decisions based upon facts and figures become possible.