In this series, I will be discussing the positive and negative effects of budgeting, and touch upon how a SaaS planning solution could enhance the effect of the positives, and mitigate many of the negative aspects of budgeting. But first I would like to discuss budgeting in more general terms.
These days, all but the smallest businesses relies on budgeting in one form or another. They do this not only to plan or estimate various future scenarios or evaluate/control various financial metrics, be it cash flow, sales, revenue, but also to diagnose the overall condition of the business, through CVP analysis (cost-volume-profit), and Sales Mix analysis.
Though budgeting can be a good way to steer and drive the development of many aspects of your business, there are also some inherent risk and pitfalls with budgeting that can have the opposite effect. I will discuss both sides of the coin below. Lastly, I will make the case that Financial Planning Software, such as Adaptive Insights that we offer here at Shearwater, can enable your business to benefit from the positive aspects of budgeting, and at the same time, mitigate or eliminate many of the negative aspects.
To start with the good, one of the key benefits of budgeting, as also mentioned in the beginning, is the fact that it forces management to think long-term. Too much focus can be lost in the day to day management of a company. Budgeting creates a venue for management to consider planning orientation, and a chance to build Model Scenarios, or what if situations, estimating the financial results of various strategic decisions. On a more conceptual level, it also offers management the opportunity to reflect upon why the company is in business at all, what is the environment like, how is it changing, how will the business, or parts of it, be affected further down the road.
Furthermore, detailed budgeting can be used to review key performance metrics or KPI’s of the company. One could be profitability review, eg. Where does the company make the most of its money, what area of business or type of products should be expanded and promoted more, and which should be reduced or shut down. Creating Budget versus Actuals reporting is beneficial for providing feedback to employees on how well they are achieving their goals. And if the company has a system in place for cost reduction, budgeting can be used to create cost reduction targets.
Budgeting can also help predict cash flows increasing the odds of avoiding a sudden cash crisis. And if cash is limited, it can help management decide on cash allocation, or what fixed assets are worth investing in and which are not. Finally, budgeting is a strong tool to estimate/measure progress, something that current or potential investors often require before committing or reaffirming their investment in the business.
Having discussed the positives, I will here outline some of the most common and pervasive negative aspects of budgeting.
First and foremost, budgets are only as strong as they resemble the economic environment in which they were created. Inaccuracy then is a major factor and can occur suddenly, especially if there is an unexpected downturn in the market. In this case, a budget must be overridden, or the business may run budgeted levels of expense, that are unsustainable in the new environment. If the budget is adhered to too strongly, it can lead to overly rigid decision making. If the budget has little room for flexibility, continuing may put the company at a disadvantage if assumptions on which the budget is built change. Also, budgeting is time and resource consuming, especially if budgeting has to cover volatile sections of the business that change constantly.
Furthermore, budgeting can create some internal friction between managers and departments, and some unhealthy habits can develop, especially if budgets and meeting targets at too tightly tied to bonus payments. If budgets are not met, inter-service departments may look to lay the blame at another department. Likewise, there may be resistance against expense allocations if departments are forced by company policy to use internal, yet more expensive services. Some may also be tempted to introduce budgetary slack to game the system for better outcomes, especially if they have high bonuses tied to performance based on the budget. This can devolve into very insidious behavior, and a bad circle where in the end the good managers will leave, and the sullied ones will create ever inventive ways to earn their bonuses. Constant oversight, especially if bonus plans are tied to the budget, is therefore needed for these negative aspects not to develop in the first place.
Finally, it can be mentioned that while budgets mostly consider quantitative financial metrics, that are evaluated to optimizing profits. Customers, on the other hand, are mostly indifferent to whether a business is turning a profit or not. What they want are quality products, good service, and fair prices.
Cloud-based SaaS, FP&A software.
Having considered some of the positives and negative aspects of budgeting, how can we make sure to make the most of the positive aspects and mitigate the negative aspects to the furthest extent possible. We would suggest employing a SaaS planning system, and at Shearwater we recommend Adaptive Insights. Their cloud-based FP&A system, enable any organization harness the advantages of budgeting by:
Simplifying and speeding up the process of creating budget plans for almost any business scenario imaginable. Enabling managers to create as many iterations or versions of budgets as is needed, fast and efficiently. It uses a sheet layout users of Excel would be familiar with, but allows for almost any custom/calculated metric to be utilized and evaluate by building reports based on those metrics. Want to know how well the sales of Item A of Color B is going in Region C, and how well the result is stacking up against the budgeted/planned sales? Or how new hires, new machinery or increased production of a given product affect overall profitability? No problem, this type of report can easily be generated in the drag and drop report builder within Adaptive, pulling relevant actuals and budget data from the cloud. All without having to type a single line of code.