Answer – yes and no! Let me explain.
The pros and cons of using budgets in business has enough pages written about it for many years. Some argue for and some against.
The main arguments for are that businesses can convert their objectives into financial performance targets or annual budgets that can be measured as the year progresses. These can also be used for incentivising managers and departments to achieve their budgets or exceed them. Budgets are used to track monthly progress and gives management and the Board the ability to better plan future activity.
The main argument against budgeting is the corollary to this, in that the whole process can get subverted so that managers become adept at manipulating budgets and ‘lowballing figures’ so that they always build in a comfort factor and achieve their targets without too much effort. This can permeate through the whole organisation. The other main issue with the budgeting process is that it takes and inordinate amount of management time and in a large organisation it can take several weeks and months and is out of date soon as the first month passes.
After having endured the pain of many years of the annual corporate budgeting process, I recommend a different approach.
When you are starting up a business, the discipline of setting a budget is very useful both for you and for everyone else working with you. It gives a focus and also helps any investors in the business monitor progress. You can track expenses and make sure money isn’t wasted. This would be expected by most investors and they would probably want to see the budget matching up with the business plan figures they invested into.
However, soon after you start everything will begin to change! Market volatility and technology is such in the 21st century that the business won’t go according to plan and will need several changes in tactics and strategy. This is when you have to adapt very quickly and comparing actual financial performance to a budget set many months ago won’t help anyone in assessing what the business needs to do.
This is where I recommend when a business needs to adopt rolling forecasts rather than annual budgets. Rolling forecasts would be adapted from a budget to start with and then as every month progresses, a forecast is made for the 12th month on a rolling 12 monthly basis. So every month, you always have a forecast for the next 12 months. The advantages of doing this is that you and your managers have a continual pulse on the business and will get better at forecasting with time. Key performance indicators can be built in and contingency plans drawn up if the forecasts show that the business will face problems. It also gives the Board, investors and funders such as banks a realistic picture of the future cashflows of the business, at any time.
No other financial statement will give this and it also avoids a lot of work if you ever need short-term funding from the bank, when they ask for your business forecasts.
Rolling forecasts are becoming more popular with companies and large multinationals such as Unilever have dropped budgets in 2010 and probably more will adopt it. As some say, budgeting is a 19th century tool that is not suitable for the 21st century!
So I recommend that if you’re starting a business, prepare the first annual budget and within the first quarter start preparing rolling forecasts to ensure your business can react quickly to changing circumstances.