Creating useful, accurate budgets is one of the most common, persistent thorns in the side of every business owner. Not only is the process of putting them together painful, but if a manager does ever stop to compare their actual performance with what they projected, they are opening themselves up for potential disappointment.
So how do you create more useful, more accurate budgets that help? There are four keys to creating powerful budgets:
First – Approach Your Budget the Right Way
The hardest thing about budgeting is knowing how and what to think about your budget. First things first, your budget is not a prediction—or a premonition of what you think the future will hold. The one golden truth with creating budgets is that the only thing you know for certain is that your budget is going to be wrong. Embrace that fact, and use it as a tool for discussing potential scenarios, and to help you discuss the potential ramifications of different decisions you could make as business.
Second – Break it Down
One of the most common mistakes we see in budgets is a tendency to either over-complicate the budget, or to have a budget that is estimating high-level numbers from thin air. We, as humans, are terrible estimators. We think it will take us 15 minutes to cook dinner, and it takes us an hour. We are often overly optimistic, and that trait tends to show itself in our budgets. By breaking “revenue” down into the various driving accounts and components, and then look at each driver a month or quarter at a time, we can be much better estimators.
Don’t think you’re the only one that overestimates. For example, Boston’s “Big Dig” highway project finished five years late and billions over budget. The Denver International Airport opened 16 months later than planned and nearly $2 billion over budget. Keep a realistic approach in your budgeting, and be sure to break down your budget and plan into the basic components that drive the numbers.
Third – Contingency, contingency!
Remember, your budget doesn’t have to perfect. That’s not the goal. The goal is to create something useful to benchmark against and to encourage discussion. One of the best ways to avoid potential discouragement is to use contingencies. By stuffing in a “catch-all” bucket of say 20%, you are able to deflect some of the uncertainty and even plan for it. The use of the contingency weapon is a powerful emotional tool.
Fourth – Don’t be Afraid to Reforecast
The beautiful thing about a budget (once you realize that it’ll never be perfect), is that you can change it at anytime. The budget is a tool for you to evaluate performance and discuss potential decisions. Three or six months into the year, you may realize that you budgeted off of an assumption that is no longer going to hold true for the current year—say, you decided not to buy the building in which your business is officed because you’ve decided to move locations at the beginning of next year. That is A-OK. Revise your budget, reforecast the rest of the year, and take heart in the fact that the change has brought about more useful discussion.