The purpose of any budgeting or forecasting activity is to obtain a forward looking view of the business in order to facilitate resource allocation and decision making. The financial forecasts you prepare are a means to that end, not an end in themselves. You need to have this business focus in mind throughout the process.
Your starting point needs to be a strategic and operational discussion with the Board. A clear outline is needed of the plans for the business over the period in order to guide the detailed budgeting.
Without knowing what product lines are planned to be introduced or withdrawn; what facilities opened and closed; what major programmes of activity are in contemplation, preparation of a detailed financial plan is impossible.
Arising out of this discussion, you should be able to prepare an estimated ‘top down’ Profit and Loss for the period which will give you a target to aim at for the detailed budget.
Planning and organising
Once the strategic and operational guidelines are in place, you can then plan the budget process in detail. Issue a outline timetable to everyone involved.
Usually, you will start with a detailed sales forecast. You need to work closely with the sales team to define the products, customers, volumes and prices that are going to prevail.
This defines your level of activity for the purposes of building up your cost budgets.
You should then provide operational managers with raw data to build up their budgets. They will need to know the operational and strategic assumptions, inflation rates, sales volumes and data on performance in the current year. You should tightly define the format in which they send you information in order to make it as easy as possible to enter to your master budget model. You, or one of your team, should be available to support them in this exercise.
This should give you the basic information to prepare your operating profit and loss.
You then need assumptions on
· Borrowings & Interest
· Capex & disposals
· Working capital movements
· Share issues
To allow you to work up a balance sheet and cash forecast.
Ensure you leave time in the plan for your team to pull the various components together and for at least one re-working of the budget if the original version is unsatisfactory.
Tools and systems
Everyone has access to Microsoft Excel and it is possible to build very effective budget systems with this software. You need to be particularly aware of the risks of spreadsheets and the ease with which errors can creep in.
Don’t exclude the use of specialist budgeting software. Well implemented, it can dramatically reduce timescales and improve accuracy. Look for a product that allows you to control different versions of the budget and that integrates well both with Excel and your main business software.
In the first year of use, you need to allow plenty of time for implementation.
You will probably end up with myriad versions of the budget applying different assumptions. Keep a log of the versions with the changes that were made so that you know exactly what each version represents.
When you have final agreement on the budget, ensure that all involved are circulated with data they recognise and that they can work from.
Libraries of books have been written on budgetary behaviour and the way in which the process can lead to highly dysfunctional outcomes. The sort of unintended consequences of the budget process you need to be aware of are:-
· Budgetary slack. People build in a contingency because they wish to improve their chances of achieving the budget and because they expect their budget to be negotiated downwards.
· Upward hockey sticks. Budget holders conserve resources in the early months of the year, and then ensure they spend whatever remains in the final months. The company is unlikely to get good value for money from this behaviour.
· Downward hockey sticks. People overspend in early months, then cut back drastically to ensure they achieve the budget for the year.
· Parochialism. People view the budget process as a means of getting the best deal for their department regardless of the interests of the business as a whole.
· Arbitrary cuts. If the budget doesn’t produce the right overall result, management make cuts which override the detailed work budget holders have done. This wipes out any feelings of ownership the budget holders may have and is highly demotivating.
It is probably impossible to have a perfect budget process, but these sorts of effects can be overcome by:
· Involvement of the budget holders
· Clear communication on all sides. If everyone understands why budgets have to be cut, it won’t be quite so harmful.
· Honesty and plain speaking.
· Careful planning, as already described.
Involvement is probably the key issue here. You need to understand the pressures on budget holders. For you, the budget is largely a number-crunching exercise that needs to be got through as expeditiously as possible.
For a budget holder, it is one of the key aspects of his or her working life. It determines whether activities will be properly resourced or cut to the bone; whether staff can be adequately rewarded or have to be displeased by tight pay settlements; whether interesting and challenging projects can be pursued or whether the department will just grind out its basic functions; even whether the manager has a chance to be seen by his or her boss to be doing a good job.
With so much at stake, it is no wonder that feelings run high. It is very important for you to be seen to take these concerns seriously and be communicating clearly with all involved.
So far we’ve talked about the process for a once-yearly budget. But of course, the process of forecasting doesn’t stop there, as shareholders will always want to know an updated position for the year – often before the budget is even agreed.
What you want to avoid at all costs is having to repeat the full budget process several times. You should argue strongly against anyone who tries to make you do this on grounds of cost and efficiency.
The best approach is just to produce an update to the budget, taking into account actual performance to date and significant known future variances. You should be able to summarise this in just a few lines.
Budgeting and forecasting can become an immensely time-consuming and frustrating exercise. You have to employ careful planning and systems techniques, and to be aware of the behavioural aspects, to ensure that your process is as efficient and free from bias as possible.
Budgeting and forecasting is a business process before it is a financial one
Plan and organise your process to the utmost
Leave time for revisions and debate
Use technology to the best effect
Be alive to the behavioural aspects of budgeting
Ensure the maximum involvement of operating managers
Steve Lloyd qualified as a Chartered Accountant and as a Finance Director he has experience running the finances of a huge variety of organisations. He believes that the discipline of financial management is essential to any business but is insufficiently understood.
Steve leads the Prospero network of Finance Directors, supporting businesses on an on-demand basis. The part time finance director service is a brilliant solution for businesses that need expert financial management, but don’t need a full time person.