The Top 10 Traps of Budgeting

Companies keep driving into the same traps in the budgeting process. The fallout can be serious in boom times; in the current economic climate, foibles can take an organization so far off course that it never gets back into the game. Here are the most common traps - from no-brainers to complex pitfalls - and tips for sidestepping them.

According to a business consultant, when one COO was asked how he plans to cope with his company's upcoming budgeting challenges, his reply was: "We just plan on making more money. Problem solved." That attitude didn't sound so crazy last year, but few companies can expect to increase revenue in a recession.

How are businesses dealing with the 2002 budget and the processes involved in creating it? Most are using basically the same methods they have always used. And they're running into the same obstacles they've hit year after year.

Here are the 10 most common traps that cause budgets to go awry in both the best of times and the worst of times - and suggestions on how to correct them.

Perhaps the number one problem with budgeting is that companies dive into the process without first formulating their strategic plans. That approach is common but backwards, according to Omar Aguilar, executive director at Gunn Partners in Boston.

"The budget should reflect the resources needed to accomplish strategic and tactical plans, but companies do the budget without taking those considerations into account," Aguilar says. "Then they put too much detail into the budget to try to cover up this mistake. You need to define your strategies first, then lay out operational tactics for achieving those strategies, and only then should you begin to allocate the resources you need to support the directions you've chosen."

Companies often lack solid costing information, so creating a meaningful budget is difficult. That was a problem Michael Odom faced as a new president of Phenix & Phenix Literary Publicists Inc. in Austin. "We didn't know what it was costing us to do business," says Odom, a former business consultant. "The company had been guessing what things cost, but there was no plan for out-of-the-norm contingencies and no accounting for the costs of tasks performed within the company."

William Levi, a CPA and budgeting consultant for the Lang Group in Bethesda, Md., believes most line managers don't understand their cost management responsibilities. "Managers need an education on how to develop a comprehensive model of what things cost," says Levi. "They need to look at the components required in making a determination of the cost, not just simply say, 'Well, we'll add 8 percent this year to this line item.' "

Budgets dictated by senior executives who fail to gain adequate input from frontline managers usually result in disaster, says Paul A. Dunn, partner in the business consulting practice of Arthur Andersen LLP in Dallas. "The budget is developed by the CEO and senior managers based on strategies they formulate, but the business unit managers have no input," he says. "Consequently, they aren't aligned with those strategies. Then the business managers start complaining about unfair allocations, claiming senior management never had any real idea of their business needs," he explains.

When budgeting is a two-way exercise, managers feel ownership of the resulting targets, which motivates them to take responsibility for working within spending parameters. "It makes the budget more achievable because they're the ones who have the frontline view of the resources required to get the job done," says Kenneth A. Hiltz, principal of Jay Alix & Associates, a corporate turnaround and restructuring firm in Southfield, Mich.

Business managers' compensation frequently depends on their ability to hit budgeted thresholds. Rewards of this kind can lead to deception. "If the manager submits a number and it's approved, and then that manager goes over the number, they're tempted to hide the overage by deferring costs to a later period," says Levi.

A better policy is to base managers' compensation on hitting performance targets, such as an improvement in customer satisfaction or an increase in market share. Budgeting does help keep costs in check, but when enforcing cost controls could cause the company to miss a potentially lucrative investment opportunity, it is unwise to be inflexible.