I have been involved in creating budgets before, as well as setting priorities for the overall budget. One system of budgeting I am familiar with is zero-based budgeting, in which every year, those involved in the process start from a zero base and must create appropriate justifications for each dollar allocated within the budget. This type of budgeting really makes everyone focus on the essentials of what keeps a firm moving forward, as well as cost tradeoffs and sacrifices that sometimes must be made along the way.
Too many times an organization becomes stuck in a mode where every year’s budget just involves taking last year’s figures, adding a certain percentage to each category, and then stamping a new date on it. Potential investments or upgrades may be taken into account as well, but little attention is paid to trends in revenue as a function of the budget. This creates unnecessary bloat and an environment where wasting resources may become common. This is a difficult situation in which to focus on key priorities within the business. An example of successful budgeting within an organization is JP Morgan Chase.
Along these lines, I have utilized return on investment (ROI) analysis as part of zero budgeting, to ensure that money is not wasted on ineffective expenditures year after year. Defining the organization's expectations for ROI was the first step in addressing investment and we had clear guidelines as to what would be acceptable in terms of time frame for repayment. In some cases, a $500,000 could have been returned in under the timeline and would be passed, but a smaller investment would be denied based on its return. To me, the key to determining ROI is to consider all potential impacts of the expenditure and all potential revenue. As an example, when making a decision on a large piece of equipment I not only weighed the costs of installation, purchase, and transition time, but also training, additional maintenance, and potential for product loss based on ramp up. Conversely, increases in revenue are the obvious returns, however, there are potential savings in terms of process changes, labor, customer satisfaction which was included in the calculation. I have found that including all of these factors can drastically change the outcome of the ROI calculation. Being harsh and demanding, with every budget dollar, brings better results in the long run. Resources can be shifted to areas that bring in more revenue.
Generally, in budgets I have participated in, it is important to identify strategic goals, and then create the budget with these goals in mind. This fits hand-in-glove with zero-based budgeting, and thinking in terms of ROI, except in instances where there may be a longer-term project that will require budget funds today but may not produce revenues next year or even the year after. Establishing the goals and strategy is just one step, but an important one.
From there, it comes down to project revenues and costs/expenses. I have always liked the idea of being bold in some other areas, but a little cautious on the budget, so that it is easier to stay in the black at the end of the year. This may be the most challenging part of the budgeting process for me. This is because of the tradeoff. If I am too cautious with outlining expenditures, we may lose opportunities or not be prepared for additional costs which may result from continued operations. I enjoy taking risks, but usually, like to do so in a way that will not put the firm in a situation to be surprised by an event and not be prepared to handle most things effectively. This is a constant balancing act: prudent budgeting versus lost opportunities. After a while, you come to know the talent at the company, and the likelihood that they can make a project work, and this makes taking risks in the budget easier.
Variable costs add some intricacy to budgeting, and this is where allowing for some leeway really helps in making sure the company can plan for the future effectively. You want to be ambitious with profit margin projections in the budget, but allow some room to accommodate changes You balance a belief that your company can do even better next year, with a desire to not unnecessarily back yourself into a corner.
Making the core mission of the company the priority was always something that budgeting groups I have been a part of have stressed. A constant re-evaluation of costs and expenses will shift more company funds toward the most important and productive areas of the firm. My budgeting approach involves a hunt for cost-savings, and creativity in applying savings to maximize their benefit to the bottom line.