There are several ways people have tried to budget—and each offers a different measure of success, or many times lack thereof.
One popular way is what I call the Ego Method. This is where ownership reviews the Income Statement for the year just completed. They look at the Earned Revenue figure for that year, see it was $450,000 (for example), and for no reason other than to placate their own ego, set a goal of $600,000 for the next year. Why $600,000? I haven't the foggiest. It just seems like the thing to do.
Another way to budget which has a strong following is the Growth Method. Here ownership looks at the company's trend over the past few years, sees it has grown an average of 25% per year (for example), and declares, "If it ain't broke, don't fix it," and sets a 25% growth target for the next year. But how much sense does that make?
Yet another method is the Inflation Method. Here ownership looks at local statistics measuring inflation, and the record says inflation was 5% last year (for example). Because they can think of no reason why not, they increase all of their figures by that inflationary 5%. "Hey, inflation was 5% last year, so let's increase all of last year's numbers by 5% and that will be our budget for next year!" Now, is that good thinking?
Last is the Percentage Method. Here ownership picks a sales figure with which it feels comfortable (typically driven by the ego emotions) and then figures all of next year's expenses based on the same percentages to sales as they were last year. We won't kill any brain cells with this one, either.
All these methods are what I call Budgeting Faux Pas. They all focus on the top line. If they seem a bit baseless to you, it's probably because they are. Budgeting is not hard, but it's not this easy either.
A legitimate working budget is a series of decisions, overt decisions by top management, which describe in numeric terms how the coming year will progress. It is a logical process which begins with the basics. And, the most basic of all questions is: Why are you in business?
Is it because of sales? Of course not! Then why? I submit that you are in business for two reasons: Profit and Fun. If you are making a Profit, the good news is that you're probably having some Fun. However, if the Profit is not there, business can be a real bummer.
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