Most organizations are ensconced with the specious practice of budgeting. It works well as a means to estimate costs and allocate money to make sure costs are covered. In addition to estimating costs, budgeting is often the means by which capital is allocated for potential investments. Often, budgets are established on a yearly basis and capped. Individuals or groups within an organization have a budget that they are responsible for and can use throughout the year.
Unfortunately, when budgeting is done in advance of the particulars of an investment, a budget can become an artificial constraint that limits the potential of future investments. It becomes a fixed amount of capital, regardless of the potential opportunities for investment.
Say an organization creates yearly budgets. An opportunity could come along mid year with the potential to pay a significant return. But, if that investment requires an initial capital expenditure that exceeds the yearly budget, it’s possible the investment will be dismissed outright.
If individuals want to pursue the investment, they’ll have to reach out to others with available funds and convince them to invest with them. Even if they can convince others, it’s an uphill battle that places an artificial barrier in front of making the investment.
If the responsibilities of groups within an organization aren’t well aligned, it’s possible others won’t share in the rewards of the investment and will be hesitant to contribute their budget to the endeavor. Even if it will lead to an overall benefit to the organization. And of course the act of partitioning separate budgets often creates silos of responsibility that don’t overlap, let alone align.
Because budgeting is fixed and it’s difficult to align interests to combine budgets, budgets often become the focal point of making decisions about potential investments. The investment may not be well understood, but the budget is set in stone.
The investment ends up tailored to the budget. Instead of focusing on maximizing the value of an investment, the focus is on minimizing the impact on the budget. That means minimizing the cost. Minimizing the cost results in minimizing the effort. And, minimizing the effort is a surefire way to minimize the value of an investment.
Investing less leads to inferior results. Especially when the conversation begins with reducing costs to meet an arbitrary budgetary constraint. If potential results aren’t understood, people are gambling at best.
I refer to this as a let’s see what happens approach to investment. Start with a fixed budget, minimize the effort necessary to produce an unknown outcome, and see what comes of it. It’s wishful thinking that the investment will be worthwhile. Sometimes it pans out, most of the time it doesn’t. Which leads to a downward spiral of smaller and smaller investments in a hope to minimize the inevitable loss.
Maximizing results requires first discussing potential results. Only after the potential is understood does it make sense to discuss potential expenditures. From potential results, it’s possible to plan for potential expenditures with increasing costs but also increasing value. These options provide increasing investment opportunities.
A lower investment, say Option A, may require $10K in potential expenditure and hold the potential for $20K in return. Option B may be $20K for $50K in return. Option C may be $30K for $200K in return. Of course investments also entail intangible benefits, I’m just using the above figures to convey understanding potential investments.
With a set of options, it’s possible to ask the question: which of these investments should we make? If they all provide reasonably well understood value, it’s a matter of deciding which potential expenditure is justifiable. At this point, it’s possible to discuss limited capital, the impetus of a budget, to decide what may be worthwhile. It might make sense to make a minimal expenditure of $10K in Option A with the understanding that the outcome will be reduced, but at least that’s a trade off that can be made. At least people know what a maximal expenditure could produce.
Budgeting should follow a prospectus, it can’t lead.