Budget or Not to Budget

Budget or Not to Budget

Planning is a process of accurate future outlook – informed by the past, accounting for the present, and reliably plotting the future. In planning you are not guessing what the future will look like. You are trying to see what outcome you may expect if certain assumptions are met.

And a budget is a monthly detailed snapshot or a milestone of such outcome to be achieved in a given year. It is in a way very static and as such it needs to be understood.

It represents one of the 5 pillars of a prudent CFO (the others being financial modelling (or brainstorming in finance), valuation, strategic planning, and rolling forecasting).

But when a budget is erroneously seen as money allocated to divisional managers for their expenditure and at the same time as the key decision document to follow regardless of the latest developments on the market, it is a very dangerous tool that can do more harm than good for a company.

Yet properly used and crafted budgets can be effective communication tools that assist a company’s navigation through agreed strategic plans and valuations as defined by top management. E.g. proper budgeting communicates business approach to employees and defines boundaries. 

For effective planning & budgeting, integration is the name of the game. So P&L, balance sheet, cash-flow should all be singing from the same hymn sheet. Being solely cost (revenue) driven just doesn’t cut the mustard – short cuts reduce affectivity and increase risk.

Integrated budgets should also include sales plans, working capital elements, CAPEX, debt service, etc. The sales plan determines material purchases and inventory build-up, which is than transformed into a production plan with costs and cash outflows.  Mistake here, can create potentially big cash flow problems especially for companies with longer term working capital cycles.

And again, a budget is a snapshot, important for a defined time and for specific purposes only. Rolling forecasts should instantly replace – or supplement – the original budget as the financial year rolls-out.