If You Fail To Plan, You Plan To Fail

If You Fail To Plan, You Plan To Fail

Are you a planner? A recent discussion regarding the validity of budgets prompted me into really diving deep into my own thoughts on the subject. The most ardent opposition to a formalized budget process tends to deal with its validity, that oftentimes almost the instant one is published a significant shift in a business process or assumption can take place and change it materially. Although I have seen this happen to an extent, I haven’t seen a budget’s value, if done properly, diminish so much that the time and resources used to prepare it are considered wasteful. In fact, even in some extreme examples such as product line shifts or regulatory changes the operating budget still provides significant oversight value.

In order to defend the budgeting process, you have to know what intrinsic value it provides to an organization. I believe you can break this down into three overarching goals. They are:

  1. Get the entire organization on the same page
  2. Set goals in order to judge the effectiveness of management
  3. Provide insights into how the business actually functions

The first goal is important because it communicates to everyone in the organization the firm’s future outlook for a certain period. If there is an expectation that top line pressures will occur, then communication to reduce or at least not significantly add to fixed costs in terms of overhead and administrative personnel can happen. If the business environment is expected to improve then the organization may decide to make significant investments in fixed assets in order to generate savings or move into additional product categories. In any case, the budget adds value to the discussion related to where the business is going and gets “all hands on deck” to meet challenges.

The second goal of budgeting creates a benchmark in order to judge the effectiveness of management. For example, if revenues were to drop, is management properly allocating resources such as labor? One telling metric I always look for is how overtime is trending. Does it stay consistent regardless of volume? If so, there’s probably a floor supervisor not cutting employees when they should.

Holding spending levels from management also goes beyond how labor and materials are applied. One large category, known as “discretionary spend”, is a bucket of money that can be used by management for whatever purpose they see fit within a certain confine. For example, one large line item in the discretionary spend bucket relates to travel and conference fees, which can add up quickly. This type of spending often doesn’t have contracts involved, so it’s easy to overspend here or cut back if need be at any time.

The third goal of budgeting is probably most important because it is here that we can quantify how the business operates in very certain terms. For example, we can set numeric goals for material and labor attached to production schedules, which will generate a variance if there’s a discrepancy that we can research in the future to see how well our assumptions fared. If we have an unfavorable variance in labor we can look to see if certain processes are running less efficiently than before. If it’s favorable, maybe there was an increase in efficiency found that maybe we should investigate in more detail. Either way, it gifts us with a tool known as “variance analysis” that can be incredibly beneficial in managing the business. In fact, you can judge how well a budget was formulated simply through the process of variance analysis. If it was done correctly, all variances are explainable. If not, your budgeting person probably needs some help.

As you can see, budgeting offers myriad benefits to the organization in terms of how to manage it. Organizations who do away with the process often meet significant obstacles in the future, in particular those related to cost changes and scale shifts. It is seen time and time again, that if you “fail to plan, you plan to fail.”

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