Have you faced with situation, when you budget your revenues and expenses and come up with a good profit result for your company, but when it comes to actuals, actuals change your picture drastically? If yes, then there was a cognitive distortion during the budget preparation. But what is cognitive distortion and how does it influence people?
Psychologists refer to systematic erroneous tendencies in perception, memory, thinking, and judgment as cognitive distortions. At their core, cognitive distortions are psychological traps that we unconsciously fall into because most decisions are made not after detailed and slow thinking, but by acting quickly, on autopilot.
This happens because our brains don't want to be stressed. Therefore, they quickly throw solutions at us, often trapping us into cognitive distortions. Such traps are especially dangerous when working with budgets and money.
Cognitive distortions can give us many benefits in everyday life. However, they mess things up when it comes to finances.
Overconfidence is one of the most important cognitive distortions that prevents us from being realistic in forecasting revenues. When we are faced with complex tasks, there is often a gap (blind spot) in our head between objective reality and overconfidence in our judgments.
Overconfidence leads us to overestimating our abilities and revenues, or underestimating the consequences of possible failures and making wrong decisions. Thus, when it comes to actuals, revenues turn out to be less then budgeted, while expenses stay as planned. Subsequently profits become lower if not turn to losses. Combined with a certain risk appetite, the above-described situation can lead to dangerous situations and even jeopardize our future or the future of our company.
In order to successfully deal with such a cognitive distortion, we need to learn to recognize our limitations, such as lack of skills or knowledge in certain areas and incorporate limitations risks in our budget. Do not be afraid to delegate tasks and involve specialists with the necessary set of knowledge and skills.
Should you need any help or have questions, My Best CFO Team is always happy to help.
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