A budget is a quantified version of your strategic goals. Therefore, having a sound budget in place is instrumental in driving your profitability and also in averting any number of adverse consequences that may arise as your business grows.
To prepare you for the upcoming budget season, here are the 9-step guide to budgeting and a checklist for monitoring your budget that we believe is the cornerstone for a standard budgeting process.
Read more: A primer of budgeting
9-step guide to budgeting
There is no one way to budget. As your business progresses through its life cycle and as its goals change, you may find that one step or two are needed to add to the budgeting listicle that we offer here:
Step 1: Define goals
Before embarking on your budget, clear objectives must be specified and communicated transparently to every stakeholder. A clear set of organisation-wide goals, among others, helps people get to grips with what the budgeting process aims for and what they have to do to ease the undertaking.
You should take a long, hard look at the situation and decide if the budget you are setting is to stimulate growth or to maintain the current status. All in all, your objectives should be clear and measurable.
A budget, and the goal thereof, is shaped by the organisation's management style and for that matter may be:
- Imposed by top authorities on mid-level executives for executing, as in the top-down approach.
- Put forward discretely by functional managers for approval, as in the bottom-up approach.
- Compromised by both senior executives and middle management, as in the negotiated approach.
Step 2: Consider financial policies and procedures
In tandem with the organisational climate and market conditions that constantly change, the budget and with it the budgeting process is now entirely subject to dynamism and complexity.
Therefore, having in place some forms of formal schedule to budget, or a budget manual is now an accepted norm in organisations regardless of scope and models.
In the case of SMEs, a budget manual could be as simple as a computerised or paper-based guideline that is formally issued across the company. As to giant corporations, it may end up a set of long-winded financial policies and procedures where strategic and financial goals are outlined, and the budget-setting process is instructed.
Step 3: Update historical assumptions
By and large, it depends on which approach to budgeting your organisation adopts yet taking the last period’s assumptions and accordingly adjusting (typified by the traditional budgeting) may be a good starting point for this year’s forecast.
Step 4: Consider limiting factors
Limiting factors are those determinants that constrain growth, and hinder sales volume and production, be it the scarcity of resources, the lack of labor or raw materials, or the fluctuation of demand.
As they directly impinge on and could be detrimental to your planning and budgeting effort, a systematic analysis of these factors needs to be accounted for right up front.
Step 5: Track fund flow
Continuously keeping tabs on the current inflows and outflows of financial assets will help you better your variance analysis and identify deviations from the forecast.
Step 6: Consider fixed and variable costs
You may find accurately forecasting sales for the next period is hopeless but managing cost, beyond question, is feasible. There are typically two types of costs that need to be considered and differentiated: fixed costs and variable costs.
- Fixed costs remain the same regardless of changes in sales and production, i.e., rent, depreciation, administrative costs. For example, fixed costs are characteristic of software companies where investments are mostly funneled into technical equipment.
- Variable costs have a directly proportional relationship with changes in sales and production, i.e. raw materials, direct labor, packaging. For example, variable costs make up most of the spending of consulting firm where consultants and their commission are responsible for the lion’s share of costs.
Managing these costs is important in part because operating leverage, simply defined by the ratio of fixed to variable costs, needs to be balanced out otherwise the company would be subject to risks and uncertainties. The higher the operating leverage, the more likely your business is exposed to uncalculated risk.
Step 7: Employ appropriate budgeting method
Again, there is no one way to set a budget. We argue that you should study your business’ model, needs and other influencing factors both in and out of the company to choose a best-suited budgeting method.
As the business grows and the market shifts or collapses, many alternative approaches to budgeting have been introduced as substitutions for the traditional method. Some of the widespread practices, including the traditional one, are presented as follows:
- Incremental budgeting (traditional budgeting): as simple as making slight adjustments to the prior budget.
- Zero-based budgeting: by starting from the basis of "zero" to budgeting, every cost must be justified based on its relevance and significance to your business.
- Rolling budgeting: iteratively adding a new budgeted period whenever the previous one was expired at pre-set intervals.
- Activity-based budgeting: adopting the activity-based analysis where key cost drivers are identified and are the major focus to which funds are allocated.
Step 8: Gather further information and set the budget
Check these boxes before finalising your budget:
- Stakeholders such as divisional managers hold the key to unlocking insights into the business that could help or hinder your budgeting effort. Make sure you articulate the process clearly to them and leave no stone unturned in your search of their invaluable contributions and inputs.
- Overlooking external factors could make every figure on your budget off the mark. Therefore, the next step to take is to review all these determining factors, which could be inflation rate, market conditions, and interest rate, to name a few.
- As a budget have implications on every entity in your organisation, it needs to be a concerted effort of and gain traction from these individuals. For that reason, make it certain that you accumulate their requests for budget modification.
- Go over all the figures one last time to make sure that they are still aligned with the targets. This could be carried through by reassessing your premature budget or consulting your accounts department.
Step 9: Formally issue the budget
Once you have responded appropriately to all the requests for adjustments from stakeholders, either by rejecting or complying with, the budget is ready to see the light of the day. If necessary, do a pilot experiment on the budget.
The budget-monitoring checklist
You may have acknowledged that setting a budget just makes for some links in a complex budgeting chain. And as data get stales quickly, you may need a budget-monitoring procedure in place.
1. Make sure every figure adds value
To ensure that your final budget is a worthwhile effort and your overall planning and budgeting process a value-added enterprise, every expense should be regularly tracked and justified for these following qualities:
- The extent to which the expenditure is relevant and significant to the business
- Categories of expenditures and their sum
- Ways by which the expenditures are met
2. Reach out to the accounts department
Obvious as it may seem, many organisations overlook this step. At the most fundamental level, the accounts department is a data warehouse that could provide every figure and information you need to compute a budget.
3. Have a monitoring procedure in place
Introducing a sound system of monitoring is a strategic move that keeps you on top of all the costs and income. This procedure of budget monitoring must be able to scale and accommodate your changing needs of growth, to boot. Therefore, it needs to be tailored specifically to your business' model and needs.
4. Setting period for budget monitoring
Determine the time frame or the frequency with which you want to look back on the budget and reexamine it. Depending on the purpose of the budget, it could be ranging from daily to monthly.
5. Identify and resolve variances
Leverage the information you have at hand to identify and calculate deviation from projections. These variances are inevitable (at the end it is what the budget supposed to be - hardly correct) and they could either be:
- Positive or favourable if you have underspent
- Negative or unfavourable if you have overspent
One way to resolve budget variance is to ensure that all the stakeholders are continuously reported on the budgeting performance. Knowing how well one’s spending is aligning with the forecast will give them the basis for providing you with valuable insights to take appropriate corrective measures.
6. Iterate your monitoring process
To accommodate the volatile nature of the market, make your budgeting and budget-monitoring a continuous process.
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