What companies get wrong when budgeting

One of the biggest unsolved challenges modern businesses face, from a budgeting perspective, is the paucity of data.

The CFO needs to determine what to invest in and prioritize how to get the biggest bang for buck, and to do this they need data. Without data, CFOs tend to revert to really simple models like the size of their budget and headcount to manage their business, and this means people don’t have to justify the return on investment (ROI) of what they’re doing.

Good budgeting is about getting people to think about how to optimize each dollar they spend. For example, someone in marketing might put forward a project that is going to create three opportunities for every dollar spent. This may sound exciting, but what if you could put less money into Google AdWords and create five opportunities? Three sounds good, but five is better.

The problem is people aren’t thinking about the best place to spend money, because businesses reward managers for having bigger budgets and more people. There is no incentive for them to really optimize what they spend, creating this lingering challenge.

In most organizations, people just need to fight for their budget and headcount. So what actually happens is that variable expenses, which is money spent on consultants and external activities, often increases. This is because it’s easier to spend budget than get more headcount, and people are rarely held to account for those expenses. People will actually go out of their way to spend their budget so they don’t lose it in the next year.

Often these external programs are far more expensive than if the activities were done internally. This is the bizarre thing about budgeting. Companies will spend money on externals but won’t hire people because there’s a hiring freeze. This is because no one has the time to go line by line and analyze every part of the business.

Instead, organizations put in place a structure and a budget and hope that the managers will act on the best behalf of the organization, but they don’t. Managers often act in their own best interests. Having a bigger budget and more headcount are internal symbols of wealth and power in organizations. So if you want people to step up and say that they don't need more people or budget, organizations should reward them rather than remove their status.

With data, organizations could actually hold people to account on how they spend money and the CFO would be in a much better position to control expenses. They could optimize investment in activities, manage new revenue streams and make the right decisions based on ROI.

So, how did organizations end up here? Well, you always know exactly how many people are working in your business and how much money you’ve spent. So budgets and headcount are easier measures than going through every expense line by line and analyzing the ROI on it. The reality is, the budgeting cycle doesn't allow you to manage your business.

At Yellowfin, we’ve flipped our budgeting process. Rather than being annual, we now have a quarterly budgeting cycle. We only provide a budget for the next quarter based upon what's working and what's not. This has allowed us to focus our attention on spending the dollars where it counts.

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