Budgeting at a Time of High Uncertainty

April 15, 2022

As times become more and more uncertain, many organizations have a difficult task in budgeting as a vehicle for planning. Leaders that are risk-averse (i.e., the (A)-style leaders) will default to the most conservative budget. They know that it is prudent not to spend money too liberally in a time of uncertainty. But the side effect of conservative budgeting is that it might dampen a company’s commitment to doing its best. The company will aim for the lowest expected results. This is especially true for companies in which rewards are based on how well a person fulfills the budget goals. So, out of self-interest, people will aim low, impacting their own drive to excel and push themselves to peak performance.

Meanwhile, the high-flying leaders—very optimistic types who aim for the moon (i.e., the (E)-style leaders)—will want to drive the company to its best possible performance. Being optimistic by nature, they will push the organization to perform discounting uncertainty. The side effect of this approach may be that revenue numbers are missed, and the company might overspend based on assumed revenues that did not take into account the forbearance of uncertainty. Revenues are iffy. Expenses are certain.

What to do?

We need both the peak-performing budget and the risk-minimizing budget—an ideal budget may just have to be a compromise between the two. But to reach such a compromise can create undesirable conflict and might stymie the budgeting process. Furthermore, a compromised budget is a middle ground between the two, a compromise and as such it might neither drive the company to stretch and aim for peak performance nor protect it from overspending.

To the companies we serve, I recommend two budgets. Both legitimate. Create a budget with two columns: One for the goal-oriented budget (this is what we will aim for—results that are achievable but with the most effort)—this is the column for the entrepreneurial leader, the column to give bonuses by. And another column for the risk-averse budget, representing what we are almost certain to achieve, the column we will use to manage our expenses.

Let me repeat: One column to outline what the budget owner believes he can achieve; thus, it takes a very pessimistic view of the uncertain environment. This budget dictates what we can spend and when. A second column to represent what management expects the leaders of the unit to produce. This budget illustrates the highest level that may be achieved with maximum effort to reach peak performance, the column for which achievements will lead to awarding bonuses. One drives the control of expenses. The other drives peak performance and is for bonus computations.

Written by
Dr. Ichak Adizes