Is budgeting really a useful exercise?

With August nearly coming to a close, and with the final month of Q3 approaching, how many readers can safely say that they have spent their budget wisely for this financial year? Businesses carry out budgeting exercises for a range of reasons, but primarily to plan and allocate funds to the activities deemed necessary for the coming year. Some businesses will link these budgets to forecasts, based on previous sales and revenue figures, multiplied by some variable in order to extrapolate a potential income for the year ahead. This will have taxes removed, and a shrewd planner will allocate a portion to savings in order to provide a buffer against unforeseen shortfalls in revenue.

The remainder will be divided up between departments – some for operations, some for HR, some for marketing, and sales, and IT and all the other myriad activities associated with the running of a business. Good businesses will put in place targets, performance indicators, and will attempt to plot ROI (Return on Investment) in order to best judge where to allocate funding. Department heads will lobby for bigger budgets, arguing the importance of pet projects and pay rises for key staff. Once the budgeting process is finalised, some experts argue that a measure of flexibility should be in built, in order to allow extra funding for special projects or unforeseen circumstances. This should not be too well known, or too easily accessed, to prevent chronic overspend (after all, incentives to remain on target financially would be reduced, if more funding would be easily available).

Once this planning has taken place, and departments begin to spend the funds allocated to them, how quickly should a business begin to re-evaluate the budget? If the sales department were to repeatedly spend money on an activity which generated no sales, or if the HR department were to pay one employee so much that the remainder of the company were underpaid by market standards, how quickly should a business adapt?

In larger businesses, regular reviews are generally scheduled to take place, and in my opinion, the cost to small businesses of neglecting this can be catastrophic. Monthly reports on the activities of departments should take place, with regular oversight of expenditure and quarterly evaluations of what funds are being spent and what ROI is being generated. Too often, I see businesses doing something and attempting to justify it because that is what has always been done, or because someone else is doing it. Instead, a business should be asking what ROI is the funding generating. If a senior manager is being paid enough for two other employees, then are they capable of generating the return foregone by not spending that money on one individual rather than two? If the marketing department is visiting conferences, then what business are they bringing back afterwards?

In short, the changes required in the operations of a business in order to maximise ROI should be at the forefront of every executive’s mind, along with the myriad of other issues such as employee welfare, social and environmental conscience, and innovation for new products and processes which can keep the business moving forward in an ever changing world. The question arises, however, why it is that so many businesses seem to waste such vast sums of money for such poor ROI.

This phenomenon can stem from a range of issues, including initial forecasts being over-optimistic (you’re more likely to allocate funds generously, if you believe revenue is going to be higher), inability to be flexible as circumstances change (infrequent reviews), or even departments developing a ‘spend it or lose it’ mentality – whereby they spend regardless of potential value in order to maintain funding levels.

So how can businesses go about fixing this? I believe that if businesses are able to more closely tie budgets to accomplishments, rather than simply targets, we can take a strong step in the direction needed. Look at how departments are achieving their targets, as well as the longer term and tangential effects of this – for example, if a sales team brings in 20% of its target in the month of December, hitting their yearly target, but does this by threatening customers with price hike the next January, this will undoubtedly have an adverse effect on longer term performance.

Secondly, businesses need to be honest about what activities and measurements are really worth to their performance and that of their customers. With the advent of modern social media and a flourishing online marketing industry, the range of KPIs available for measurement seem to grow by the year, but without a clear understanding of the meaning of these measurements they are entirely useless to measure. Likewise, carrying out activities because it’s what the business has always done, or because someone heard that a competitor is doing it is no excuse for carrying out ill thought-out vanity projects is no excuse for poorly performing activities either.

It’s an often repeated mantra by those on the right-wing of politics that private businesses are efficient, and that the public sector is not – but I believe that it is ultimately the individuals who carry out the actions of these enterprises that determine their success or failure. Poorly thought out, wasteful projects exist on both sides of the public/private divide, and both sides must be equally ruthless in seeking out and eliminating wasteful expenditure.

This battle to eliminate such expenditure comes in part from during the process of creating budgets, and partly from the evaluation of the department they were assigned to. Make the effort to rid yourself of just one wasteful project a month, and you’ll be working to prevent historical mistakes dictate future failings!

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