On budget
Everyone who has worked at a senior level in corporate environments has experienced the budgeting exercise—a box-filling procedure designed to predict what will happen months into the future and translate it into financial numbers. In my previous company, we used to start this process as early as June. Sheets and templates would begin floating around, filled with columns comparing actuals against the previous year’s numbers, the current year’s budget, and next year’s budget.
You start by reviewing recurring sales from long-term contracts and venture into the sales pipeline, applying success percentages and time factors to recognize revenues. You also add estimates for new revenue-generation initiatives, such as new product launches, business development activities, or any other figures linked to operational strategies.
On the cost side, direct costs are estimated based on revenues, with some initiatives aimed at capturing efficiencies. Similarly, indirect costs are estimated based on historical and actual figures, with adjustments made to support either rising revenues (e.g., sales and marketing costs) or decreasing ones. In a matrix organization, these figures must circulate and be validated by business line managers, regional managers, and global support function managers to ensure alignment with their respective strategies.
The more people involved, the longer the process takes, creating multiple feedback loops and rounds of discussion. Negotiations happen at various levels. For instance, you might estimate a revenue for your region, only to have it challenged by a global manager. Or you might attempt to reduce support function costs, only to see them increased globally. This is why starting as early as possible is necessary, though the time and energy spent are often mind-boggling.
By November or December, once the budget is finalized and approved, it provides a framework for alignment across different managerial levels. This is meant to guide "proper" decision-making and also serves as a key metric for setting group and individual objectives and performance evaluations.
At this point, the description might sound like something from a course on planning—whether from the perspective of strategy implementation or financial planning. It seems logical and well-structured. But once you start doing it in the real world, you quickly realize that it’s deeply wrong.
Let’s begin with the obvious: the budget is based on assumptions made months, even a year, in advance. When decisions are made on such assumptions, things can and will go south. A major problem with this approach is that managers base decisions on these outdated figures. I experienced this firsthand in a conversation with a marketing executive who asked if I had a budget for a new marketing initiative I wanted to launch. Her question essentially boiled down to: "Did you think of this initiative last year when you were preparing your budget based on last year’s assumptions?" My answer was no—I wanted to base my decision on today’s opportunities, not last year’s assumptions.
Using a budget as a decision-making tool is problematic, and the reason is simple: change. Things happen in the future—opportunities emerge, people leave, new hires are made, customers buy more or stop buying altogether. These are things we can’t predict. The world is uncertain and constantly changing, even in business.
Another troubling aspect is that when budgets are used as performance tools, they get gamed. Economist Charles Goodhart famously said, “When a measure becomes a target, it ceases to be a good measure.” This is particularly true for budgets. First, benchmarking against past assumptions is not smart. Why would anyone do that? Second, managers tend to manipulate budget figures to maximize their own benefit. For example, support functions often inflate their resource requests to align with new initiatives, and they may accelerate spending at the end of the year just to prevent their budget from being cut the next year. We’ve all seen this. Managers responsible for margins will lowball revenue estimates during negotiations to over-deliver later. When a good year is ending, some even delay extra business into the following year to look better. This is no how business should happen.
The budget has morphed into a tedious, fictional exercise aimed at maximizing bonuses rather than running the business effectively. What started as a benchmarking tool has come to dominate how businesses operate. In the chaos of business, the only factual thing—the budget—has become king, dictating decisions and actions.
I would be tempted to leave the budget in the graveyard of bad management tools. However, my experience as a financier has taught me that the only thing that truly bankrupts companies is a lack of cash flow. While obvious, it’s crucial to recognize that cash fluctuates with changes in operating margins, working capital, and capital investment. Companies need cash to finance their operations and investments, and these needs arise both from strategic initiatives and from unexpected changes in the business environment. A sudden rise or fall in revenue can bankrupt a company, and growth often requires working capital or new investments. Likewise, a decline in revenue must be managed to minimize the impact on cash flow.
Thus, the budget does have a role to play—as a financial risk mitigation tool. It helps prepare for future cash flow needs, whether in the short or long term, and allows businesses to plan financing strategies accordingly. But it should not be used for decision-making or performance management. Instead, the budget should be managed by financial experts to mitigate cash flow risks. The process be quick, adaptive, and revised continuously by people closest to the business. For example, changes in major customers, capital expenditures, or anything likely to affect costs should trigger adjustments.
One might ask: without a budget, what benchmark should we use? The answer is simple: last years’ actual figures. This is a more reliable measure than fictional, negotiated numbers. Although this shift might unsettle executives accustomed to relying on budgets as a key metric, it’s the only way to refocus attention on actual business.
