Written By Mark Rygelski: Chief Financial Officer at Good Luck group
Budgets are traditionally woven into the fabric of most businesses. Everyone uses them. Banks require them. Employees expect them. They are treated as something revered and to be adhered to without question.
But, in reality, budgets are terribly ineffective management tools.
Dwight Eisenhower once said, “Plans are worthless, but planning is everything.” He was referring to war, but the concept applies to business and budgets in particular. When you create a budget, you can do your best to plan for the unexpected, but the very definition of “unexpected” dictates things never happen the way you think they will.
Budgets are inherently inflexible.
They’re usually based, like last year’s performance, on stale information and assumptions about things that are going to happen 12 months or more in the future. Budgets are wrong the minute they’re completed. However, many companies continue to stick to the budget as their management tool no matter the circumstances or, even worse, constantly make changes to the budget to equal actual performance.
Using the budget to manage a business results in both leadership and employees not thinking critically about spending or revenue opportunities. Two common scenarios are:
1. Employees make poor business decisions to avoid going over their expense budget (or reach their revenue budget).
2. They spend all the money in their expense budget, whether it’s needed or not, so they don’t lose it next year.
More and more businesses are moving toward operating without a long-term budget and working with 13-week cash flows instead. Kristen McAlister, President of Cerius Interim Executive Solutions, says that 13-week cash flows are an excellent alternative to a traditional budget. “There are a number of situations where the revenues are so erratic that doing a budget and trying to benchmark against it is seen as a waste of time when you could be spending time on the business,” says McAlister. “Thirteen-week cash flows are easier to keep updated to the ebbs and flows of business and provide a better picture of reality to make business decisions from.”
That’s why, when I began my tenure as CFO of GL group, we made the decision to abandon traditional budgets. We believe sound business decisions should be based on what’s best for our employees, our customers, our operations and whether the decision will help us in the future — not on a budget.
That doesn’t mean we allow a spending free-for-all or that we don’t pay attention to our financials. It’s the exact opposite, actually. We spend a lot of time and effort analyzing each financial decision we make. We navigate the budgeting process not by focusing on the goal of accurately predicting the future with a finished masterpiece called “The Budget” but by analyzing and discussing opportunities to improve the products and support we provide to our customers, to perform better operationally and to enhance the lives of our employees. We focus on the ever important “planning,” as Eisenhower suggested — and less on the actual plan.
If you’re interested in moving your company away from traditional budgets, you must start by looking at the planning process differently and making every financial decision a conversation.
Create two months’ worth of forecasts.
It’s much more accurate to make predictions two months out. Base those forecasts on items similar to an annual budget, such as contractual obligations, projected expenses and sales estimates, but move them closer to the activity. Not only will you be able to make an educated guess versus just making a guess, but you will be continually in the planning process. You can make changes in the moment by practicing open-book management and involving your employees in the decision-making process.
Do the hard work.
Your teams should analyze every one of their financial decisions. Always do your homework, encouraging everyone from the CEO on down to think critically about every one of their expenditures or revenue opportunities. No one should manage based on whether or not there are dollars left in the budget for expenditures or if you need to hit a revenue goal.
Make it a conversation.
There isn’t always a clear-cut, indisputable ROI for every situation, so when making financial decisions, you should ask a set of questions that help you make the decision into a conversation. Then, you’ll know you’re doing the right thing, even if it costs more.
• Does this align with our culture and core values?
• Is there another solution that provides more value to our customers, our vendors or our employees, even if it is more expensive for our company?
• Is there something that is less expensive that provides the same value?
• Is the timing right to do this now?
• Do we really need to make this expenditure at all?
• What is the worst that could happen? This question was coined by our founder, Sandy Jaffe, and it is still used today in all of our business decisions.
Replacing the budget with a dynamic planning process for sound financial decision making allows you to affect the outcome of the game while the game is being played.
Consequently, forecasts are much more beneficial to everyone, from the CFO to managers, leadership and employees. You’ll be able to achieve your most important goals and objectives as opportunities arise — not just when they happen to fit budget numbers.