Projections ≠ Budgeting

Non-financial people often confuse budgeting and projections. Let’s delineate the two to aid you in the use of these powerful tools.

Delineation

Projections basically take the approach of “If I keep doing what I’m doing today where will I be three months, six months or a year from now?” Projections are often updated monthly, if not more frequently, based on how quickly new information becomes available.

Budgeting is different in that it is goal oriented. The mentality in budgeting is “Where do I want to be a year from now, two years from now, three years from now and what do I need to do to get there?” Budgets typically only get updated annually. Updating budgets more frequently than annually risks losing sight of your goals, which virtually assures that you won’t achieve them.

Uses

Projections are used to guide short-term decisions based on what revenues are anticipated, how profitable those revenues will be and when the profits will be converted to cash. Here’s an example of why projections are important.

A new client was experiencing cash flow problems. I found out that months earlier he’d thought IBM stock looked attractive and he bought some. By the time I’d come on board, IBM’s stock price tanked and he was struggling to make payroll. Had he had projections, it’s highly unlikely that he’d have bought the IBM stock.

Budgets are designed to establish goals and timelines based on the strategy the company has adopted. When used properly, budgets also help the company’s leaders stay focused on the strategy they’ve adopted. It’s easy to fall victim to both opportunities and crises that surface during the year resulting in a loss of focus on the company’s strategy.

Caveats

The biggest caveat regarding projections is to avoid getting complacent with the accuracy of your projections. Keep seeking ways to improve your projections. It helps you stay focused on improving operations and operational results and keeps you attuned to changing trends.

With budgets, there are several mistakes that companies regularly make:

Business owners and leaders set goals without regard to the interdependency of revenues and costs. Here’s an example from an actual experience I had:

Company leaders decide to grow revenues by 20% despite the fact that they have averaged 10% over the last three years. When asked how they were going to accomplish this goal, they said they were going to grow market share. When we got the marketing part of the budget, they said that they were going to cut the marketing budget by 5%. It doesn’t take a rocket scientist to know that gaining market share requires more marketing, not less.

Another mistake is altering the budget to reflect current changes. This converts a budget tool into a projection tool. With this transformation comes the loss of original goals and deadlines that were based on the adopted strategy. In essence, a company becomes rudderless with this transformation.

In very large organizations when the budgets submitted by all departments, and assembled by the accounting department, don’t reflect the goals senior leadership has in mind, leaders often order across the board increases in revenues, reductions in expenses or a combination of the two.

This approach ignores the fact that the company’s various offerings are at different stages of their life cycles. Offerings on the cusp of launch may find it impossible to meet the elevated revenue targets, especially with lower levels of funding resulting from across-the-board cuts.

Established, still early-stage offerings may be able to meet elevated revenue targets, but again it’s going to be more difficult given the funding cuts.

Established, middle-stage offerings will find it difficult to reach elevated revenue targets since significant market inroads have already been attained. Conversely, funding cuts may not have much of an adverse effect on their operation.

Late stage, end-of-life-cycle offerings, will find it impossible to meet elevated revenue growth targets yet suffer little, if any, damage from funding cuts. Indeed, given that most budgets get created with a cushion for funding, these folks would likely still have an excess of funding even with the cuts.

While across-the-board budget changes are easy to effect on a spreadsheet, they often result in goals that are unlikely to be met.

Takeaways

Projections and budgeting are essential tools that benefit organizations in both short-term and long-term decision making. Projections aid in the short-term and budgets in the long-term.

When creating projections, continuously strive to improve the accuracy of your projections. Beside the benefits of greater accuracy, you’ll spot changing trends more quickly

With budgeting, remember that it’s focus is on goal-setting based on the strategy adopted. A budget will help you maintain your focus on the goals you’ve set and increase the likelihood of achieving your goals.

When creating your budget, remember that your expense goals should be based on what is required to achieve your revenue goals.

Avoid converting your budget into a projection tool. Doing so will result in a loss of focus on the goals you initially established.

When budgeting, don’t do across the board adjustments to your revenue and expense targets. Instead, examine where your offerings are in their life-cycle phase and adjust the budgets accordingly.

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Resources

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