What Is a Budget?

February 2006

My favorite definition of a budget is:

A budget is the translation of the plans of the organization into financial terms.

So, a budget simply converts plans into numbers. In order for a budget to be meaningful, it should be based on a meaningful plan. The plan comes first!

A budget alerts you when you are “off plan”. It screams, “Hey—something is happening here that we didn’t expect!”

A budget is NOT last year’s numbers minus ten percent. That fast-and-dirty method makes several key mistakes. First of all, it is ignoring the future. Secondly, it is assuming the guy who did the budget last year had any sense—even if it was you, your thinking last year is suspect!

Here is another definition of a budget:

A budget is a tool for management to ensure maximum profitability and utilization of resources.

I don’t like that one as well, but I do like that it says that budgets are a TOOL. Not a bludgeon, mind you, but a tool.

Some organizations have let the tool get the better of them. I know of a local city that has created a chain saw when a nail file would probably do just fine. At the airport alone, they report on 100+ performance indicators in relation to the budget. This is too much! Somehow the tool got out of control.

Sometimes, it is crazy people that get in the way of the tool working. The tool—the budget itself—does not have a personality. But the people that use it sure do! So before I can begin a meaningful discussion of budgets, I like to name and put aside several squirrelly human behaviors. I call these inherent challenges, because you can’t get rid of them no matter how smart you are about budgeting. Some organizations have these “challenges” to a high degree, while others have just a mild case.

So here is a list of inherent challenges with budgets:

• Uncertain future and outside environment – We don’t know what is going to happen in the future. Budgets are sometimes called forecasts because they predict the future. The best we can do is make assumptions and run with them. But different folks make different assumptions based on their personality and their role in the organization. Some are optimistic and some are pessimistic.
  
  The optimists in the organization might overestimate revenues and underestimate expenditures. Optimists in a for-profit environment are often the salespeople and the marketing folks. Salespeople are known to be pumped up because they listen to motivational tapes in their car. (They have to be pumped up to survive; the rejection they suffer some days is a killer.) In a not-for-profit environment, the folks who head up the programs may be optimistic.
  
  The accountant usually plays the heavy—the pessimist. Most accountants (certainly not the Enron accountants) are usually very conservative in their approach and plan for the worst. They underestimate revenues and overestimate expenses. A pessimist figures no one will be disappointed if things turn out better, but plenty of folks will be upset if things turn out worse. Sometimes accountants feel it is their duty to bring those optimists down to earth with their practical insight. (See any ego at play here?)
  
  But who ultimately is right? You won’t know until the year is over and all the results are in.

• Psychological nature of negations – Some people play the budget game better than others, and every organization has one. An executive of a shipping organization told me he would be a fool not to play the game his company set up for him. His budgets were created on a three-year cycle and he received a significant bonus if he met budget. The budget for the next three-year cycle was based on the last year of performance. So he earned his bonus in the first two years of the cycle and then blew the budget apart in the last year so that his future cycle would be fluffier.
  
  What is your game? Everyone has one. Is it golfing with the boss, whining during meetings, or finding ways to get your work done using other people’s money? Just a thought for you to consider… What happens to your charges if you don’t play the game?
  
  
• Intentions go awry – What gets measured gets done, sometimes to the detriment of the individual and the organization. For instance, my husband worked for a home builder as a construction supervisor a few years ago. This national company paid him a bonus if he was able to start and then finish a house within 120 days. That was the only way he could earn a bonus.
  
  See any issues here? The quality went down the tubes and the company lost money and reputation trying to correct the damage. Assume that a good number of people will do stupid things for the organization if it benefits them individually in the short run (I said that accountants were pessimists, didn’t I?)
  
  
• Used for evaluation and rewards – Some organizations are so rigid about their budget that people do things that are obviously wrong or silly just to stay out of trouble. That sort of relates to the issue above, doesn’t it?
  
  
• Involves numbers – I am constantly amazed by the reluctance of folks to deal with numbers. You should see a group of CPAs having dinner. No one wants to touch the bill!
  
  Some people think that the accountant should create the budget. Big mistake! Because as smart and witty as we are, we don’t know jack about your end of the business or you plans for the future. The budget belongs to management and is a tool for management, not for accounting. Accounting has its own set of data to worry with—the general ledger. The purpose of the budget is so that managers have some real time numbers to work with. Yes, accounting can help you compile it and provide data, but in the end it is the manager that is the user and the person accountable.
  
  One of my bosses was a master of pushing responsibility for creating the budget on his accountant (that was me) so that he didn’t have to take responsibility for his numbers.
  
  Our federal grant budget was due on a certain date, and if we missed it we were jeopardizing our brand-new funding. He was very smart about the game. He refused to work on the budget, calling himself a “big-picture person”. I reasoned, prodded, and begged him to create the numbers, but he always had something more pressing to do. A few days before the deadline, I was forced to pull something together and submit it without his written blessing. When he busted the budget wide open later in the year, what do you think he said? Genius, “That is not my number, that is Leita’s number and I had nothing to do with it. I can’t be held to that unreasonable expectation.” His picture is in the dictionary next to the word “shifty”.
  
  
• Cuts, cuts, cuts – Most of us are being asked to do more with less. Very seldom are we approached with an extra bag of money to spend as we like. Budgets in some organizations are about “control” and are used as a tool to reduce waste.
  
  Here is a concept for you to consider. Instead of doing more with less, can you do less with less? Can you eliminate your non-essential activities so that the budget doesn’t affect your essential activities? Just a thought… please, no nastygrams on this one.
  
  
• Time consuming – A good budget takes some thought, and getting everyone to buy into it (which is very worth it) takes some time. Some view the budget as a process that takes them away from their real job. I understand that view, AND I understand that rushing and sacrificing the quality of the budget may affect that real job.

That got a little preachy there at the end, didn’t it? Oh well. I am an accountant, after all.