Working on a Better Budget in 2014

Another year, another time to put together a business budget. However, if your business operation has been struggling the last few years, you might do things a little differently this go-round.

In the past, the budget may have hindered managers from doing their jobs and discouraged them from taking risks. This could compromise integrity, distort information and result in bad decision-making. For instance, budgeting based on data that is likely no longer relevant may not reflect where your firm should be heading in 2014 and beyond.

Similarly, numbers can be manipulated to meet easy targets or promote self-aggrandizement. Even worse, funds might be wasted just to avoid a reduction in the next year’s budget.

What is the solution? One idea is to take a long, hard look at your budget. Is it accomplishing all the objectives you hope to meet, including strategic planning, resource allocation, and performance and compensation evaluations? If not, the time may be right for a change in technique. Here are five suggestions to consider:

1. Become more dynamic. Important business decisions should depend on a realistic business plan. But the traditional annual budget can quickly become obsolete, while certain assumptions inevitably prove to be wrong. You need to move quickly to revise the budget when it is warranted.

For many firms, a quarterly review will not be sufficient.  When significant factors—such as interest rates, fuel costs or direct competition—change, you may need to adapt on the fly. Build this flexibility into your budget.

2. Allocate wisely, but react accordingly. Initial allocations are difficult. But once they are made, they do not have to be etched in stone. Just because more resources are needed does not necessarily mean you should not do it. Additional budget allocations may be allowed during the year.

When it is not feasible to have an in-depth review, you might relax some financial constraints. If you have good people in place, you need to trust them to make sound decisions without micromanaging the situation.

3. Do not focus on performance evaluation. Usually, it does not make sense to judge performance based on target numbers and assumptions that have become outdated. Furthermore, basing pay on budgets that managers set for themselves encourages them to lower expectations to provide a better chance of meeting their goals.

If possible, keep performance evaluations separate from the planning processes. Managers should be judged based on how their units actually perform during the measurement period.

4. Develop other performance metrics. Financial results do not have to be the only measuring sticks for business units and their managers. You might supplement the financial measures with metrics specific to each organizational segment, some of which are leading indicators of future financial performance. Depending on the operation, these could include attaining significant new clients or customers, success in research and development, or improvements in production, customer satisfaction or employee morale.

5. Revise budgets. Frequently, budgets are defined by exceeding a threshold, so no bonuses may be paid if the goal is not achieved. This arrangement encourages managers who could be denied a bonus to manipulate the results. If your company shies away from this approach, there will be less temptation to “work the system” and more emphasis on doing what is best for the company.

These five steps may create an environment more conducive to growth and sustained success. Managers will not be as motivated to manipulate figures and should make better decisions based on updated information. Budgeting will still be a time-consuming process, but it should be time well spent.