Budget is needed to provide a control device that can be used to ensure the attainment of commercial goals. Although budget permeates almost every aspect of a business, it tends to be much misunderstood. Let’s get 3 misconceptions out of the way.
Misconception#1: A budget is A Weapon to Say “NO!”
Many managers equate the word “budget” with the word “weapon”. They claim that budgets are useful for beating people over the head with (metaphorically, of course) and telling them what they have failed to do. They also claim that budgets are useful for saying “NO!” to people: “No, you can’t do that – it’s not in the budget”.
In fact, budgets exist to make life easier, not more difficult. Their primary function is to help managers make decisions that will ensure commercial goals are attained. Indeed, if you do not use a budget to help you make decisions, you are not using a budget at all.
Misconception#2: A budget is A Numerical Exercise
When managers are asked to provide a budget, they usually end up producing a schedule of figures. It is important to realize that the figures provide a summary of the budget, but they are not the budget itself. Consider the following conversation between a training manager and a finance manager at the end of a business year.
[Finance Manager]: How did the training department do last year?
[Training Manager]: Great! We had a budget of $200,000 and we spent exactly $200,000. Didn’t we do well?
[Finance Manager]: So how many courses did you run?
[Training Manager]: None.
[Finance Manager]: Oh! So, what alternative forms of training did you initiate?
[Training Manager]: None.
[Finance Manager]: So, what did you do with the $200,000?
[Training Manager]: It was wonderful! We paid for the entire department to fly to the Hawaii for a two-week all-expenses-paid vacation!
The budget was to provide training for staff in the company, with the intention of enhancing trading performance. It was not to sponsor a two-week Hawaiian holiday! Consequently, when looking at a budget it is not the figures that are the most important issue. What needs to be determined is whether or not managers are doing what they are supposed to do. A budget is a plan of action, it is not a set of numbers. Numbers may be used to summarize a plan, but they are not the plan itself.
Misconception 3: The Budget is Wrong
Managers often claim a budget is wrong. They then proceed to replace the budget with a forecast. Forecasts can also be wrong. If this should turn out to be the case, the forecast may need to be replaced by a “revised forecast”. Regrettably, revised forecasts can also be wrong. This may lead to the replacement of the revised forecast with an “updated revised forecast”. Updated revised forecasts can be wrong, so this may need to be replaced by an “enhanced updated revised forecast”. Bad news! Enhanced updated revised forecasts can be wrong as well, so this may ultimately need to be replaced with a “strategically realigned enhanced updated revised forecast”. Although you may have witnessed such a process in real life where a significant portion of management time is taken up continually updating and amending forecasts, this has nothing to do with the world of budgeting.
Believe it or not, a budget is only of use when someone says it is wrong. This might seem bizarre, but it is true. Suppose you are looking at last month’s trading results and are informed that trading is exactly as expected. This means that the actual figures will be identical to the budgeted figures.
What is the point of looking at two sets of identical numbers? Surely it is when the actual and budgeted results differ that the budget comes into its own. It is saying something has happened that we did not expect, so what are we going to do about it? This is definitely not the time to take the view: “The budget is wrong, so let’s ignore it”.
Creating a plan for a business is much the same as planning a holiday. You decide you want to go to the coast for a few days. Filled with enthusiasm, you sit down with a map and plan your route. Before you know it, you are in the car and on your way when you hear on the radio there has been an accident on the road ahead and a lengthy queue has already formed. To avoid this, you turn off at the next exit.
A course of action you certainly should not take at this point is to declare the map is wrong and throw it out the window! What you need to do is sit down and study the map. You look at where you are now (which may appear to be in the middle of nowhere) and where you planned to be. On the basis of this comparison, you may be able to identify another route that will get you to your destination by the evening. Alternatively, you may decide it is now impractical to get to your destination today, so you will have to stop off somewhere along the route. Neither of these decisions can be made unless you take time to compare your actual location with your planned (budgeted) location, even if they are miles apart. The same principle applies in business.
Let me summarize all the points from these misconceptions:
Ultimately, budgets are there to help control the business, by providing a plan against which actual performance can be continually compared, with any deviations being used to indicate where management action is required. Of course, none of this can be achieved unless a budget is created in the first place.
Misconceptions The Fact
A budget is a weapon =>> Budgets are there to help you
A budget is a =>> Budgets are plans of action
The budget is wrong =>> Budgets enable you to
respond to changing
The bare bones: A budget is a plan of action.