We’re a month into the new year and by now, you should have your 2023 budget firmly established. But for the few of you out there who don’t, there is still time. And for the rest of you, I’d like to address the question that comes up every year as to what is the best way to set a budget. There is no perfect answer, and to some extent, it depends on the purpose.
Are we trying to set stretch goals for your team? If so, I’m going to be a bit more aggressive both in terms of top line and expense management. It’s OK to be aspirational so long as the consequences of missing the budget are not dire. Maybe we consistently run at 20% EBITDA so we’ll construct a budget moves the needle to 22%, for example.
Are we trying to set spending constraints? In that case I’m going to be a bit more restrictive knowing that it will be acceptable to spend more in certain areas if top line results warrant. There are costs that rise and fall directly with revenue. Other expenses are fixed in the short term (rent, frequently doesn’t vary with revenue but in some cases it might such as a retail setting).
Are we setting expectations for a bank or investors? In that case, I have seen management teams set budgets they can almost certainly hit or exceed (at least for sharing with those audiences). In this situation, the management team usually has another budget with loftier goals.
Above are just a few approaches and there are many variations and ways to think about budgeting. Frankly, I like to shoot straight down the middle of the road. I believe that if you’re setting good budgets, half the time you’re going to come in higher and half the time you’re going to come in a little bit lower. If your company always exceeds its budget, that’s called sandbagging and people probably aren’t stretching to achieve more. If your company consistently fails to achieve budget, then people probably don’t take the goals seriously and strive to achieve them either.
I’m not in favor of setting multiple budgets (base and stretch, for example). That may work in larger companies where there is the bandwidth to manage communications and variance analysis, but it’s just not practical in smaller companies.
Nor am I in favor of “updating” the budget for every fact that comes to light after the budget is published. I’ve seen management teams who want to update the budget so often, that they basically turn it into actual results by the end of the year. My theory is that you took your best shot at a budget as of a certain date, it’s up to the management team to deal with both good and bad variances and deliver the profit expectation.
I will, however, reset a budget mid-year if the company is significantly over or under. There is no sense going through the second half of the year either flogging oneself for failure or patting oneself on the back for being well ahead of plan. Learn from the first half and reset for the second if necessary?
How do you set your budget?
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