Budget Development Warning Flag 1 – Division by Twelve Budgeting

Annual budget development is often time consuming and tedious, one of the evil necessities of managing a business. Subsequently, managers frequently seek shortcuts to reduce this burden; one such burden reducing action being the equal distribution of budget revenues and expenditures during each of the fiscal year’s twelve months.

Estimating revenues and expenses on an annualized basis and then equally spreading these funds over twelve months presents several risks to the business and often results in added long-term work for the responsible manager. On the revenue side, businesses seldom enjoy a steady, ongoing income. Subsequently, budgets making this assumption fail to predict cash flow shortages; endangering business operations continuity. Additionally, initiatives may be unnecessarily delayed because of erroneous projections of cash shortfalls. On the cost side, quarterly, semi-annual, and annual billings also disrupt cash flow estimates and may dangerously hamper business operations.

…and all of these budget inaccuracies and their associated business impacts will need to be explained by the responsible manager during what will become very uncomfortable budget reviews.

Perfect budget planning is unachievable. However, managers should seek to reasonably estimate the timing and magnitude of monthly revenues and costs and avoid the use of ‘division by twelve’ budget smoothing. While not all inclusive, the four lists below, Process-Based Warning Flags, Process Execution Warning Flags – Behaviors, Potential, Observable Results, and Potential Causes, are designed to help organization leaders to recognize whether their budget planning efforts are reflective of reasonably anticipatable business activities or the result of inappropriate monthly smoothing. Only after a problem is recognized and its causes identified can the needed action be taken to move the organization toward improved performance.

Process-Based Warning Flags

• Budget development policies do not demand month-by-month revenue and cost recognition planning
• Managers are not provided with historical seasonal revenue trends
• Finance personnel do not provide managers with the estimated timing of expenses to be incurred by their workgroup
• Few or no managerial performance measures associated with budget accuracy
• Few or no individual managerial performance goals associated with budget accuracy and adherence, particularly on a monthly basis

Process Execution Warning Flags – Behaviors

• Executives allow managers to practice ‘division by twelve’ budget planning during the budget development, review, and approval process
• Executives do not hold managers accountable for revenue and expenditure deviations during monthly budget reviews
• Executives hold managers accountable for budget management goals only on an annual basis

Potential, Observable Results

• Budgets show consistently level revenues even though business operations and sales tend to be seasonal
• Budgeted expenses are spread equally among all twelve months of the year
• Month end budget reconciliations infrequently match planned budgets
• Periods of extreme cash shortfalls and/or overages are frequently realized
• Operations are halted or slowed as a result of cash shortfalls
• Projects are not initiated even though there are actual excess cash reserves to do so (the projected budget indicates a lack of cash to begin the project)

Potential Causes

• Executives and managers do not fully understand or appreciate the ramifications of inaccurate budgets on cash flows and their associated impacts on business operations
• Managers believe that ‘division by twelve’ budget planning will simplify the budget development and management process
• Managers seeking to minimize the burden associated with budget development