Budgets control people, not costs
Stephen Hambling talks with Andy Burrows from Supercharged finance on financial budgeting. Watch the video and read the article.
Financial budgeting is a topic that resonates deeply with every finance professional. Everyone is engaged in budgeting, and I have quite strong opinions on it. Firstly, budgeting is not the same as planning. I believe people often don’t realise this.
What is budgeting?
So, what is budgeting? Well, if you consider it, a financial plan is essentially a financial representation of what you anticipate happening based on your strategy—your action plan. You create a financial model that predicts what the finances will look like if you follow that plan. This model is based on certain assumptions, and you can conduct scenario analyses to develop best-case, worst-case, and expected-case scenarios. That’s a financial plan. However, it’s not the same as a budget.
A budget is essentially a tool that tells managers how much they can spend. That’s what a budget is. It’s about determining spending limits. The confusion arises because a budget is often derived from a financial plan or is a version of it. One of the issues is that if a budget is treated as a financial plan, and if it’s the version intended for salespeople, it will include ambitious targets. You don’t want to use that for budgeting because it might suggest you can spend more than you actually can. Conversely, if it’s too conservative, it doesn’t work either.
Traditional budgeting does not work
You invest all this effort to predict a 12-month period, ideally completing it a couple of months before the period starts. But that does not always work with how quickly things change, how many budgets have you seen that become outdated within the first quarter of the period? All of them, yet they are rigidly followed for the rest of the year, which can be embarrassing for finance.
Andy Burrows explains “I experienced this with the first budget I ever worked on. It was a bottom-up version where cost center managers contributed figures for their areas. We adjusted the revenue assumptions, and by the time we finished, it was December, just before the year ended. We got it approved, but it didn’t make sense. Then, in January, you have to upload the budget to compare actuals, and variances appear. You start explaining these variances based on what was wrong in the budget, even though you argued about it two months ago. It becomes frustrating to repeatedly justify something that doesn’t provide value”.
Wo invented budgeting?
I believe budgeting was invented by the Civil Service in America around the 1920s to control government spending. It served as a control mechanism, and it still does. You need a way to manage and communicate spending limits to the business. However, if budgeting hadn’t been invented, I doubt we would create it as it is today. What you need is a plan that evaluates whether what you achieved is satisfactory. If your sales mix is this, if you open that office, and if you allocate resources here, then a good profit and result would look like this. Compare against that and understand your performance relative to what should be good, not against a static plan created six months ago.
The difference between a financial plan and a budget
Andy Burrows explains, “One thing people don’t appreciate is that budgets control people, not costs. That’s the difference between a financial plan and a budget. The budget is there to control people, to say you can’t spend more than this amount. Another issue is that when you set a spending limit, cost center managers will spend up to that amount, even if they could have spent 50% less. But if the sales area they support has doubled, they still have to stick to that budget. If sales have soared, they should receive more resources and money. Conversely, if sales are below target, they should cut back. It needs to be more dynamic. We need to understand that it’s a cultural issue because it’s about decentralizing control. It’s about management control, which is a philosophical concept. People don’t realise it because we’ve lived so long in this business environment in the West, taking for granted that we have cost center managers and delegated authority. But it doesn’t have to be that way. Budgeting stems from decentralisation, empowering managers to spend what they need because the CEO or CFO can’t make every spending decision. We need to empower them and give them discretion without overspending. You have to give them enough freedom to make decisions while allowing them the latitude to do so”.
Beyond budgeting
For those interested in this topic, the Beyond Budgeting Institute (BBI) is a great resource. They have taken this concept to the next level with excellent case studies and hold annual conferences in attractive locations. We’re not affiliated with them, but it’s a topic that will gain prominence in the next ten to twenty years. We can’t continue with budgeting as it is because, of all the areas in finance, budgeting is the worst problem. It’s the elephant in the room, and everyone hates it. Why aren’t we doing something about it? I agree with Beyond Budgeting. I became fascinated with it in the 90s.
About Stephen Hambling,
CEO and Founder of Kybos, a UK based Jedox partner.
I provide simple, clear, commercial forward looking financial support to founders, entrepreneurs and CFO’s of Small and Medium sized companies. Typically I’m the special projects guy, commercial troubleshooting, systems help, M&A or cashflow & turnarounds. I’ve implemented several hundred finance systems. Implementations are not a core skill set for the average finance team, so it’s easy for a project to go off track. Clear simple guidance before, during and after an implementation can make the world of difference.
Other content you may like
Aout Kybos
Kybos is a dedicated UK Jedox gold partner. We build planning and analysis solutions that deliver value fast using accountancy qualified consultants. Whether you want a fully customised application or to build upon an existing solution, Kybos consultants are here to help.