Three elements of an effective budget

Post by
Dan Hully
Three elements of an effective budget

A good budget is one of the key points of contact between finance and the rest of the business. Done well it fosters control and empowers teams. Done poorly it leads to disorder and confusion. In my career as an FD and external advisor I’ve seen both extremes.

All good budgets have three elements below in common.  These article is intended to be a five minute primer on why they’re important, and how to ensure that you get the most from them.

  1. They control spending;
  2. They measure performance and;
  3. They help set the strategy;

1) Control spending

Your head of operations asks whether she can spend a thousand pounds on a great new scheduling tool.  What do you say?

With a detailed budget you have a pre-built framework for making the decision.  

Is there room for the tool in the department’s budget?  If not, then there should be a compelling reason for why a tool is needed now that we hadn’t thought of a few months ago.  If there is, then you should be able to trust the team member to make good decisions about how they want to allocate the money that’s been allotted to them.

When you’re drafting a new budget it’s important to give team members ownership of their own budget lines.  This gives them the ability to make decisions with full knowledge of available resources (and reduces the workload of the finance team!).  More importantly the sense of ownership and control motivates and empowers the brightest employees.

2)  Measure performance

When you measure something, it improves.

At the end of a month, how do you know whether your financial performance was good or bad?  You can compare your income to the previous month, or the previous year, but in a seasonal or high growth businesses this comparison is not enough.

Measuring your performance against budget allows you to see, at a glance, whether or not you are on track to achieve your strategic plan.

Tracking performance is important not just at the business level, but at a department level too, and you should share performance against budget regularly with team leaders to get the full benefit.  

Sharing this information with the team is useful because it shows them how their work fits into the wider picture, and how they’ve performed against their own targets.

3) Set the strategy

There are a number of different stakeholders in a growing business: founders; investors; employees; mentors.  The best companies are able to get these disparate groups all bought into the same vision and pulling in the same direction.    

This process starts with team discussions, moves onto more formal board meetings and finally gets solidified with a budget.  Because a budget is so detailed and comprehensive it forces you to clarify your thinking and to iron out ambiguities.

Once a detailed strategy has been agreed on paper at the start of the year this forms one version of the truth that you can look back on to settle arguments and ensure everyone is bought in to the mission.

Fast growing companies are unpredictable, and the budget you create at the start of the year might not reflect what happens later – That’s fine.  The budget is not a document that you should always try to follow no matter what, it’s a snapshot in time that says ‘at the start of this year we all agreed that this was what we planned to do.’