Too often the budget is the domain of accountants with their arcane talk of models and their dreary, repetitive spreadsheets. Let’s get this straight right up front: accountants are a service group. They assemble the budget for the owners, management and operations. They later use it in their reporting service to management and operations. Ownership of the budget goes with ownership of the business plan.
I am going to approach this stimulation of thought by asking what requirements we have of a budget and what uses we put it to. If your budget satisfies the discussion below then it will serve you well. If it does not, then you need to work on it.
The Budget Proves Out the Financial Viability of the Business Plan
The business plan includes inputs from many facets of the organization. These might include new products, research, new assets, new directions and the ongoing business. The budget brings all pieces of the business plan together in the single language of money expressed on a timeline. Though often the business plan and the budget data are prepared close to concurrently, it is a useful exercise to consider how the organization holds together financially.
This is the point at which risks can be assessed by challenging the business plan assumptions. For example, what if revenue is 10% off by more and less? A change in assumption has a ripple effect throughout the organization. In the revenue example, if revenue is lower, it may mean that asset acquisition must be through external financing rather than out of profits, and the implications of this must be explored. Ask the question “What will this mean to us if it happens?” and explore the implications thoroughly.
Some notes on this:
- The process is more important than a deadline. Be thorough.
- You cannot do this unless the duration of your budget matches the duration of your business plan.
- Always assess risks even though they may have a low probability of occurring. The process can provide insight.
The Budget Quantifies Goals
The budget does not set goals. The business plan sets goals. The budget provides the measure of the attainment of those goals over the timeline of the budget.
There is a tendency to think of the budget as only a financial document. Yet the budget is the financial reflection of hard facts, eg. payroll is people working hours for a contracted rate of pay. The number of people and the hours they work are as important to the budget as the dollars.
The quantification of goals is often expressed as Key Performance Indicators (KPI). The budget must facilitate the quantification of the baseline for these.
The Budget Provides Discipline in Performance
The essential elements of a budget are a breakdown of expenditures and a timeline. For a department to meet its budget it must consider both elements and how it will achieve them. This provides a degree of structure and discipline to operations. Time and circumstances may render the budget a less effective tool for this but the baseline provided by the budget must receive consideration.
The Budget is a Component of Monthly Operational Reporting
Let’s start by dispelling the myth that a budget has less value over time. The budget was set as a baseline against which anticipated performance can be measured. The measure of variation from budget may become significant, however, a methodical analysis of the variances will still lead to a full understanding of operations, assist in ongoing forecasting and aid in subsequent business planning.
The standard reporting format is a statement of revenues and expenses for a time period, usually month and fiscal year to date, with the related budget and the variance between the actual and the budget. To this will be added in depth reporting on variances and a report on Key Performance Indicators.
The essence of this is the variance. The variance is the difference, positive or negative, that the actual result is from the component of the budget against which it is compared. A variance has the measure of its component (eg. dollar, unit, hour).
If you prepare a budget that does not fully document the components on which it was based you will not be able to analyze the variances in sufficient detail to effectively manage the organization.
Some notes on this:
- I have laid emphasis on the components. You must have systems in place to measure them. You cannot control what you cannot measure.
- Make sure you have meaningful statements at a department or project level so that line management may analyze their results and control their areas of responsibility.
- Formalize the reporting of variances and KPIs. Ensure that this is at a component level.
- Be methodical in the analysis of variances. Get to the root causes. This is a “call to action” at the operational level.
The Budget is the Base of the Forecast
I am a huge advocate of forecasting. Do it monthly or quarterly to suit your needs. Though it does not need to be as comprehensive a process, think in terms of strategy, business, budget. Have discipline.
Your first forecast was the budget. Document why your subsequent forecasts vary from it. Include the forecast and notes on it with your reporting package.
Conclusion
If you have critically reviewed the requirements of a budget and can honestly say that you are happy with yours then it will serve you well as an ongoing management tool.
Postscript
In my three articles on strategic plans, business plans and the budget I have tried to stimulate thought on their uses and preparation. Though I am an advocate of considering these three areas as philosophically different, I am aware that they generally blend together in practice. Though this is so, I advise that you do stand back and consider them separately and recognize the need for each area. We tend to do this annually but at least do the strategic plan when necessity dictates.
Roger Andrews (click to see Roger’s profile)
Principal
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