Preparing a budget is a common exercise for companies no matter what their size is. Budgets can also benefit small companies or even individuals. Budgets can help us to be prepared, to review our performance and to control our costs.
Budgets are broadly used not only for internal reporting purposes but third parties can often rely on them. For example, a bank can ask a company that is seeking funding to prepare a three to five years budget. While it is expected and reasonable that the forecast figures and the actual figures will be different, it is not uncommon that budgets often fail in terms of predictability and in terms of credibility. There are a few reasons for that but the top 7 reasons are as follows:
- Intention to present a good image: We often have the incentive to be overly optimistic to secure funding from a creditor or to convince investors.
- Excessive Optimism: People tend to be overly optimistic when it comes to money. I believe that it is in our nature to expect growth and to look forward to better financial days.
- Reliance on historical data: It is true that historical data should be used to develop forecasts and to prepare budgets. They can be a great source of feedback that can boost the quality of our budgets. On the other hand, companies are dynamic. Putting too much emphasis on what has already happened and assuming that nothing will change can jeopardize the quality and the reliability of a budget.
- Technical Skills: Sometimes, preparing a budget is not as straightforward as one might thing. Companies can be complex and preparing a budget for a service line or a product that requires allocation of overhead costs or forecast of costs that can greatly change can be a difficult task.
- Forgotten Costs: It is not uncommon for specific costs to be completely forgotten. It is more common for fixed overheads to be missed since people often focus on the variable costs. The fixed costs however are often high enough that can jeopardize the accuracy of a budget.
- Unanticipated costs: It is true that no matter what skills we have and no matter how hard we try to prepare a reliable budget, there are costs that we will not be able to predict. Truth is that things change and what happened in the past is not a guarantee for what will be happen tomorrow.
- Incorporation of feedback: A budget is developed so that we can anticipate, monitor and compare. The comparison between the forecast and the actual figures is often missed. This exercise can help us to understand what assumptions were wrong and why.