Budgeting Versus Forecasting: Why You Should Throw One Away
It’s happened again.
You went through the effort of creating a budget… only to have your first quarter results be completely different due to inflation and marketplace changes.
If it’s not COVID, it’s inflation. And if it’s not inflation, it will always certainly be something else.
So, what do you do now?
How can you measure your future business performance against expectations that no longer have any relevance?
NOT WITH A BUDGET!
Want to watch instead of read?
Throw Away The Budget (Kind Of)
I know it can be hard to say goodbye to an old friend, but It’s time to throw out the term budget, especially when using it as a tool to measure performance.
It’s an archaic method that is somewhat useful in certain situations – like non-profit events, municipalities, and big companies that want to control spending – but not for measuring business performance.
As a small business, your budget needs to be tossed in the same trashcan that you threw your father’s desktop accounting software after trading up to a cloud based accounting system, like Xero.
Budgeting versus Forecasting: What’s The Difference?
If you don’t use a budget, then what do you replace it with to help measure your business performance to expectations?
The answer is a forecast.
Before we get into the proper forecasting process, let’s look at how Merriam-Webster defines a budget and a forecast so you understand what makes them so vastly different.
Definition of budget
- A statement of the financial position of an administration for a definite period of time based on estimates of expenditures during the period and proposals for financing them
- A plan for the coordination of resources and expenditures
- The amount of money that is available for, required for, or assigned to a particular purpose
Definition of forecast
- To calculate or predict as a result of study and analysis of available pertinent data;
- To indicate as likely to occur
Is a Budget Ever Useful?
A budget is an estimate of what you would like to occur for your business.
(Here is the best process for creating one).
You do it one time a year and use it to compare actual results, in order to see if you are over/under your goals for the year.
Its best use is to set controls around certain expenditures to help protect your cash flow.
“With a budget, you’re requiring the organization to stick to plans with little or no appreciation of how the world has changed”
John Hrudicka, CFO Elkay Manufacturing.
“It sucks the energy, time, fun, and big dreams out of an organization. It hides opportunity and stunts growth. It brings out the most unproductive behaviors in an organization, from sandbagging to settling for mediocrity.”
The book Winning, by Jack Welch, Former Chairman and CEO, General Electric
While creating a budget is not a terrible exercise for a business owner to go through, it does have its limits.
Once a budget is created, it becomes obsolete as the world around you and your business changes.
To keep trying to measure a constantly evolving landscape against a fixed unchanging budget is not a good way to measure the performance of your business.
What is the Alternative to a Budget?
If expectations have changed then our business goals need to change as well, and this is where forecasting comes in.
I have been presenting and preaching on the topic of forecasting for over a decade now, from association meetings to a $100M+ sales organization, and they all suffer from the plague that budgets bring.
If you want to measure what you spend versus a controlled budget, then by all means keep doing it.
But, if you are looking to grow your business and improve its enterprise value then you must stop what you are doing and start implementing a forecast.
Stay tuned for next week’s blog when we’ll take you through the recommended process of dynamic forecasting.
In the meantime, if you’d like help with forecasting for your business you can reach out to our team any time. We’re always here to help.
Simply book a 15-minute call to learn more.
Until next time!