It is the time of year when most companies are doing their budgeting for the next year. This can be a frustrating and time consuming exercise. It is also important.
Does every company need a budget? I don’t think so. Smaller companies, where the owner is very close to the transactions, may not need a formal budget. But even small companies can benefit from planning for the future. Planning will help you achieve your goals. Perhaps the thought process itself is the biggest benefit. There is power in thinking through your plans and committing them to writing.
For all but the smallest companies, a budget is the formal plan, put in quantified terms. Should a plan be static? Absolutely not! Businesses deal in a dynamic environment and flexibility – financial and otherwise – is essential.
One approach is to make multiple budgets. Yes, this is more work, but much of the underlying baseline for these budgets can be shared. My favorite approach is called SRO budgeting. SRO stands for Survival, Realistic and Optimistic.
The Survival level budget is the lowest level of revenues which allow the business to survive in its current form. While one wouldn’t aim to achieve this, it is helpful to know that level. If this revenue baseline isn’t reached, drastic survival level tactics will need to be implemented.
The second level is the Realistic budget. This is the best guess at next year’s financial performance. This is usually the budget that is input into the accounting system and used for budget versus actual comparisons. Most accounting softwares will only accept one budget. If there is a “real” budget, this is it.
The Optimistic budget is just that; what might be achieved assuming things go better than expected. This shouldn’t be so optimistic to be completely unrealistic. It should be potentially achievable if optimistic assumptions are met.
The Realistic budget is the one used for financial comparison reporting as the year goes by. The Survival budget is the one you keep in mind if things get tough. And the Optimistic budget is the one the company strives for, especially those responsible for making sales happen. In fact, I suggest that every day, week and month, top management and the sales people ask themselves, “What have we done to achieve our optimistic numbers?”
SMART is another acronym I find helpful. It is used in goal setting that typically is a part of the annual budgetary process. SMART goals are:
Specific—Think what you are going to do, why do you want to do it and how will you do it. Make it clear.
Measurable—If you can’t measure it, you can’t manage it.
Attainable—Good goals cause you or the company to stretch. Unattainable goals de-motivate.
Realistic—This means do-able. It does not mean easy.
Time-bound—Without a timeframe, the goal is too vague.
A non-SMART goal would be something like: We will increase profitability next year. This is not specific, measurable or time-bound.
A SMART goal would be something like: We will increase profitability for calendar year 2011 to $1.2MM, as measured by our GAAP income statement. That would be a SMART goal if it is attainable and realistic.
SRO budgeting with SMART goal-setting provides a relatively simple method for this annual process that is sound and will result in improved performance of the company.
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