There’s a saying, “More fiction has been written in Excel than in Word,” emphasizing the challenges many organizations face when budgeting. Most businesses have a ritual: start with last year’s budget, then add or subtract based on new annual plans. After numerous iterations, a solid budget for the upcoming year emerges. But how effective is this ritual in achieving organizational goals? Here are some red flags to watch out for:
Lack of learning capacity
A significant warning sign is the absence of post-budget evaluations. If business cases aren’t reviewed, no lessons can be learned. Especially when large IT investments are made, most projects are miscalculated. The key question: was value created within the stipulated time?
No room for agility
If every dollar is pre-allocated to “must-do” expenses, the organization can’t capitalize on opportunities or mitigate threats. This rigidity can jeopardize a business. Often, managers set aside funds for projects to tackle unforeseen challenges, but this hampers the learning process.
Financial diligence is crucial. However, organizations sometimes overcomplicate things, leading to a semblance of accuracy based on multiple assumptions. Assumption multiplied by assumption equals a more significant assumption.
Managers often develop budgets bottom-up. After extensive effort, they sometimes discover the budget was predetermined, rendering their effort useless. It would be more effective if teams were given a budget and then outlined what they could achieve with it.
Financial gravity or the Matthew effect
Budgets tend to gravitate towards departments or projects with substantial existing funds, even if this doesn’t align with strategic ambitions.
The sunk cost fallacy
This cognitive bias makes it hard to abandon projects in which significant time and money have been invested, even if discontinuing them is the wisest choice.