Budgeting, as an important tool of business management, became widespread in the United States after World War II, based on public finances management models (probably one of the few examples of management innovation transfer from the public to the private environment).
Nowadays, most companies elaborate a yearly Budget as a way to anticipate their financial performance and statements for the year(s) to come.
Strategic Plan vs. Budget
The Strategic Plan contains the business objectives that the company sets for the coming years. It is formulated in qualitative, quantitative and temporal terms, and is the document that should guide the action of all the people in the company. Its formulation, approval and review is the responsibility of senior management and the Board of Directors.
The Budget, on the other hand, is the expression in quantitative (mainly financial) terms of certain scenario compatible with the Strategic Plan, with a triple objective:
• Check the feasibility of the chosen strategy, that must provide sufficient profitability to ensure business continuity.
• Ensure the availability of the human, material and financial resources necessary for the execution of the strategy.
• Allow the short-term monitoring of the execution of the Strategic Plan, comparing actual with planned figures.
The Budget reflects just one of the scenarios compatible with the execution of the strategy, since it is unusual (and certainly very risky) that there is a single way to achieve success with the Strategic Plan.
Experience teaches that the probability that the scenario chosen in the Budget is exactly the one that finally occurs is very small, especially in dynamic and volatile markets (is there any stable market left?). That is why it is advisable to perform one or several Budget updates throughout its life, adapting it to reality and confirming that the execution of the strategy is still ongoing and is still feasible, even if it is not exactly the way it was foreseen in the original Budget.
Many more actors are involved in the preparation of the Budget than in the Strategic Plan. All departments and functions, usually coordinated by the financial department, must somehow participate in its construction and follow-up. The Budget approval and review is usually the responsibility of senior management.
When the Budget fulfils well the objectives mentioned above and is also flexible and dynamic enough not to become obsolete throughout the year, it becomes an essential management tool: the Smart Budget.
The limitations of budgeting
I will not dare to question the value and the need for an adequate budget, even for small businesses. On the contrary, I believe that, effectively used, there are few tools more useful than the Budget to control the evolution of the business and guarantee the availability of the essential resources for its survival and growth.
However, I have observed throughout my career situations in which an inadequate use of the Budget limits its usefulness, being able to turn it into a value-destroying element. A few examples follow:
– Confounding the Budget with the Strategic Plan: placing both plans at the same level of relevance, or even positioning the Budget above the Strategic Plan, is a surprisingly common mistake, even in large organizations. In case of conflict, the strategy must prevail.
– Setting the Budget as the sole objective of individuals and teams: managers who believe that compliance with short-term plans is the most important thing usually set the objectives of the company and its teams around the achievement of Budget figures. This is not necessarily a problem, as long as the main objective of the organization and its members is the execution of the Strategic Plan.
All team members must be able to identify their role in achieving the strategic objectives and understand how this translates into short-term quantitative objectives, embodied in a Budget. There should not exist functions or departments that we cannot relate some way to the strategic objectives of the organization. The Budget and its successive adaptations can make part of the objectives of teams and people as long as it is clear that the Budget itself is not the ultimate objective.
– Considering the accuracy of the Budget as a measure of excellence.
The success of the company lies largely in the fulfilment of its Strategic Plan. Being capable to build a realistic Budget (sales team calculating a reliable sales forecast, marketing team correctly estimating the impact of a campaign, finance team correctly anticipating the evolution of costs and cash flows, etc.) is a good evidence of business acumen and professionalism, but it should not be considered a key performance evaluation point.
In today’s changing environment, time and resources dedicated to the preparation of the Budget should be discrete and balanced with the existence of agile and flexible processes to make it evolve over time. This swift adaptability is a better indicator of excellence – in my opinion – than the accuracy of the initial forecast.
– The Budget tyranny: killing the ambition. When reaching the objectives of the Budget (“making your numbers”) becomes the main objective, three main threats are at stake:
• Organizations focusing on the very short term, on “matching the target”, on achieving instrumental objectives and neglecting strategic ones.
• The elaboration of the Budget becoming a political process in which more or less affordable objectives are “negotiated”.
• The most damaging one: missing opportunities to go beyond the planned achievement or to accelerate the fulfilment of the strategy, since the performance measurement standard is the Budget. Going the extra mile is not valued or rewarded.
When this happens, the interests of the shareholders (reflected in the Strategic Plan drawn up by the Board) and of the employees could undertake a very negative divergence.
Shared strategy and entrepreneurship
An inappropriate or flawed approach to the functions of the Budget can generate serious business dysfunctions.
Fortunately, there are ways to avoid these blunders, this is, to build and use a Smart Budget: all them have to do with working with and for the people, the team members.
First, the clear formulation and broad communication of the company’s main strategic lines allows each individual to identify their contribution to the achievement of the strategic objectives and understand how short-term objectives are just a tool to achieve the former, more important ones. Additionally, by establishing and clearly communicating to the organization the ultimate goal of the preparation and monitoring of the Budget we will certainly contribute to its optimal use.
Likewise, by promoting (through the incentives’ and professional development’s policies) the development of the entrepreneurial spirit and stimulating the contribution of every team member to the Company’s goals, we will guarantee to a greater extent the commitment of the professionals with the strategy, objectives and interests of the Company and its shareholders. It is amazing to note how an organization involved and committed to the strategy can enhance, improve it and exceed the initially planned objectives.
Open communication and building a shared and strong business culture, together with adequate incentives’ and professional development’s policies, are key to aligning the organization’s short-term work, using powerful tools such as the Smart Budget and its control, with the achievement of the long-term objectives embodied in the Strategic Plan.
JM Noriega 2024