The real WHY behind a budget, especially for SME’s that require funding
We often think that only big companies need to do budgets. Their huge scope of operations and the distance between the decision makers and the people at the coal face need a tool to communicate company performance and expectations. It may not be the only reason for a budget, but generally considered one of the better ones.
Conversely, a SME would then not need a budget as top management is hands-on and in the office with an open door – right? Nope, what if there is another “why”?
Benjamin Franklin supposedly once said, “If you fail to plan, you are planning to fail.” A company that does no planning chooses to deal with the future like a leave deals with the wind – it can only react to events only as they occur. Business mostly understands this and therefore has strategic plans, SWOT analysis, vision and mission statements etc. in place.
For me, the main “why” of a budget process is to quantify these strategic plans.
We should not divorce the strategy of an entity from the financial planning – even if you are a non-profit organisation. There is nothing that does a reality check on a strategy than a detailed budget. I do not propose that the budget process should kill dreams and visions, I am saying that a budget will chunk down your next actions in order to obtain those dreams and visions, and keep you on track going forward.
A budget shows management’s operating plans for the coming periods by formalising the strategy in quantifiable terms – it shows expected activities. That is why budgeted performance is more useful than past performance as a basis for judging actual results. Budgeted performance takes changed circumstances and new strategies into account, past performance not. For example, if you have opened an additional branch or business unit, then your past performance will be useless as measurement of actual performance – you have to measure it against the expected outcome of that decision.
That is why it is so important not to confuse a budget with a forecast. A budget is the planned outcome of your future, the culmination of your actions as per your strategy – that what you want to achieve. A forecast is merely a prediction of the future. You can use your budget to better forecast the future, as you know your plans and options to change and influence different outcomes, but an accurate forecast will always be the most possible outcome – irrespective of the desired outcome.
When you decide your strategy for the quarter, the year, the next ten years – quantify it with a budget process. The process will differ from entity to entity but should include, at the very least:
- A base line budget that maps the result of your strategy and the resources needed to make it happen.
- A set periodic measurement of actuals versus budget – if it is not measured then it will not be managed, so measure your actual performance against what you planned in order to make sure you stay on track.
- A revised budget based on the new realities that life presents. If your strategy develops due to new opportunities or macro environment changes, adjust your budget so that your measurable planned performance always aligns with your strategy.
As I plan to publish this under my funding section, let’s link the above to the funding process for SME’s. I have yet to meet an investor or lender that does not, deep down, believe that past performance is a predictor of future performance. I am always asked for previous period budgets as well as actual performance when talking to the money people. Why? Because they want to see how well you plan and, therefore, how much trust they can put into this latest plan of yours. If you cannot present previous budgets and comparative actuals, then you limit the amount of information on which they need to make a decision – limited information increases risk and reduces you chances of success.
Show them that you have linked your strategies to the future reality with a proper budget process.