Unnecessary Spending

If we look closely we can see personal spending that was unnecessary. In business it can be more difficult to identify unnecessary spending. Ever wonder why?

Whose Does the Spending?

On a personal level it is pretty easy to know who does the spending. After all, there are usually only a few people who do all the spending. More importantly it is easier to identify whether the spending was justifiable. However, when it comes to a business it can be a little more difficult to identify who did the spending and for what purpose. Why is that? For our purpose let’s focus on small business.

Departments

Even in a smaller company there is generally some semblance of departments, even if informally. Because a department may have several people it is always possible that more than one person makes spending decisions. It is also not that unusual that the documentation of expenditures is poor and lacks a stated justification. When asked about it later people have a tendency to invent a justification on the spot.

To complicate matters, one person may have authority over multiple departments. As a result spending decisions can get concentrated in one person while lacking appropriate accountability. This is almost a guarantee of unnecessary spending, especially when combined with the next item.

No Budget or Budget Not Used

It is not uncommon for a small business to lack a budget, and even when one exists it often has very little impact on actual spending. See Why You Never Hit Budget for more on this. As I expressed in that posting it is not uncommon that the first time anyone realizes that spending is exceeding budget is when actual results are compared to budget. At that point it’s too late. The damage is done.

Failure to Justify

The reality is that even when there is a budget and spending is not done without first verifying it is planned for in the budget, there may still be a lacking step.

Justifying Spending

One of the key steps to developing a budget is to justify the proposed levels of spending. For example, imagine a trade show is to be attended. I have seen this kind of spending planned for by essentially pulling a number out of thin air. In other words, it’s a guess. Similarly, a budget amount may be based on actual spending from the prior year, typically with some percentage of increase. Also it is not uncommon to establish an amount strictly as a percentage of forecasted sales. How likely do you think it is that the sales actually realized are considered when spending decisions are made? I can tell you from first-hand experience there is rarely any real connection. But, more importantly, why should sales determine amounts to spend as a percentage, except in the case of cost of goods sold, commissions, or other items that truly are sales driven. Yet, even things like cost of goods sold often represent areas where unexpected savings may be realized. For example, are there other suppliers that offer a better price?

The bottom line is that if unnecessary spending is to be avoided, then a company needs to be deliberate about how it plans for spending and have ways to actively monitor that plan. Have a budget or spending plan, use it, and clearly designate who has authority to authorize expenditures.

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.

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