Avoid These Mistakes When Creating a Business Budget

Summary

In this video, Steve Cochran, founder of Boosting Your Financial IQ, discusses common mistakes in business budgeting. He emphasizes the importance of distinguishing between a budget and a forecast, advocating for a rolling forecast approach over a traditional annual budget. Cochran advises against treating the budget as a company's strategy and warns of the pitfalls of complexity and linking budgets to compensation. He stresses the need for simplicity, focusing on key value drivers, and using forecasts to inform and empower decision-makers rather than as a tool for command and control.

Takeaways

• 📊 **Budget vs. Forecast**: The speaker distinguishes between a traditional budget, which is often seen as a fixed strategy, and a more dynamic forecast that adapts to changing circumstances.
• 🔄 **Rolling Forecast**: Emphasizes the importance of a rolling forecast that is continuously updated rather than an annual budget that becomes outdated quickly.
• ❌ **Avoid Fixed Budgets**: Criticizes the practice of creating fixed annual budgets that don't account for the fluidity of business operations and market conditions.
• 🚫 **Complexity Reduction**: Advises simplifying the budgeting process to avoid confusion and inefficiency, which can hinder decision-making.
• 🔍 **Focus on Key Value Drivers**: Suggests concentrating on the main factors that influence business performance, such as labor, pricing, and material costs.
• 👮 **The 'FinOps Cop'**: Uses the metaphor of a police officer to describe the role of financial leaders in maintaining discipline in budgeting but warns against over-control that stifles innovation.
• 🔗 **Strategy vs. Budget**: Stresses that a budget should not be confused with the company's overall strategy and that they serve different purposes.
• 💼 **Compensation and Budgeting**: Cautions against tying compensation directly to budgetary outcomes, as this can lead to unproductive behaviors and misaligned incentives.
• 📈 **Performance Measurement**: Advocates for measuring relative performance improvements rather than absolute figures, which can be affected by external factors beyond a leader's control.
• 🔄 **Continuous Updating**: Encourages updating the forecast as new information becomes available to keep the financial planning process relevant and useful.

Q & A

What is the main difference between a budget and a forecast according to Steve Cochran?

A budget is an old process with a command and control mentality, while a forecast represents a new way of doing things. The budget is about predicting and controlling, whereas a forecast is about informing decision-makers and empowering leaders to act.

Why does Steve Cochran suggest avoiding the annual budgeting process?

Steve Cochran suggests avoiding the annual budgeting process because it often involves politicking, games, and is time-consuming. Instead, he recommends a rolling forecast that is updated regularly and is not tied to a fixed calendar year.

What is the common mistake that companies make regarding their budget?

A common mistake companies make is mistaking the budget for the company's strategy. The budget is not a strategy; it's a tool to help achieve the strategy.

Why is a zero-based budget approach recommended over rolling forward budgets?

A zero-based budget approach requires starting from scratch and building the cost structure anew, which is important for ensuring that expenses are justified and necessary. Rolling forward budgets can lead to unnecessary expenses being carried over without reevaluation.

How does Steve Cochran suggest simplifying the budgeting process?

Steve Cochran suggests simplifying the budgeting process by starting from a higher level, consolidating accounts, and focusing on the line items that drive value. He also advises against having too many accounts in the chart of accounts.

What is the role of a financial leader in the budgeting process according to the video?

The role of a financial leader in the budgeting process is to act as a 'cop', ensuring that the budget is realistic and that it serves to inform and empower decision-makers rather than to control them.

Why should compensation not be tied directly to the budget?

Compensation should not be tied directly to the budget because it can lead to gaming the system and counterproductive behavior. Instead, compensation should be based on a broader set of KPIs that reflect the overall performance and health of the business.

What is the recommended frequency for updating a budget or forecast?

A budget should be updated at least monthly, but a forecast can be updated at any time when new information becomes available. This allows for more flexibility and responsiveness to changing business conditions.

How does Steve Cochran define the ideal length for a rolling forecast?

Steve Cochran suggests that a rolling forecast should be 12 to 36 months out into the future. The point is not to have accuracy far into the future but to have a long-term view that is constantly updated.

What is the key difference between controls in a budget environment and controls in a forecasting environment?

In a budget environment, controls are based on variances from set targets, which can lead to a command and control mentality. In a forecasting environment, controls are based on KPIs and relative performance improvement, which encourages a more dynamic and adaptive approach.

Why is it important to distinguish between the budget and the company's strategy?

It's important to distinguish between the budget and the company's strategy because the budget is a tool to help achieve the strategy, not the strategy itself. Confusing the two can lead to misguided decision-making and a lack of strategic focus.