“Don’t tell me what you value, show me your budget, and I’ll tell you what you value.” Joe Biden
That’s what the significance of Budgeting is for any Organization! But Budgeting and forecasting process in any average size Organization takes extensive amount of resources and time of all level of management. So many times executives of the Organization are probed upon how the Organization’s budgeting process adds value to the business activity against its cost of delivery. There is no simple answer to this question, it all depends on the nature of the Organization and how the budgets being prepared, used and monitored. Let us first understand what budgeting is, how budgets are being prepared, what are some of the key benefits of budgets are and how to assess what is wrong in the budgeting process.
What budgeting and forecast is:
Budgeting – process of expressing quantified resource requirements (amount of capital, amount of material, number of people) into time-phased goals and milestones.
Forecasting – is essentially a recasting of the budget. It is a planning tool that helps management in its attempts to cope with the uncertainty of the future, relying mainly on data from the past and present and analysis of trends.
The preparation of annual budget is a first step followed by a forecasts to reflect the changing market conditions, strategic plan alterations, error corrections and revised assumptions as used in the annual approved budget.
Almost all Organizations preparing budgets follow more or less the same following process for the preparation of their annual budgets:
- Establishing the overall goals of the Organization to be incorporated in the detailed budgets of each unit;
- Setting up of annual targets and the level of expenditures compatible with these targets;
- Forecasting future needs, this is generally for a period of 3 to 5 years;
- Establish the assumptions to be used in developing the budgets these includes, inflation index, price and volume increases, exchange rate parity, etc.;
- Translation of Organizations targets and goals to achieve into numbers;
- Address the Organizational issues identified during the monitoring of last year budgets;
- Balance the requirements with resources. Life is all about series of trade-off, you can’t have all your wish list in one go. Priorities need to be set in considering the expected earnings against the expected expenditures;
- Obtaining executives buy in on the numbers.
As you can see the process is long and tedious. In an average Organization this process takes about 3-4 months till the budget is approved. It is necessary to clear at this stage that above steps and time are required for the preparation of the budgets only. Monitoring and control measure runs throughout the year. The changing and increasingly complex business environment, is creating new demands for the deployment of a planning process that is agile and can enable the business to react to changing conditions.
Before we decide whether it is worthwhile spending resources and efforts in the budgeting process we need to understand what are some of the key benefits that can be achieved from the budgeting exercise in an Organizations:
- Planning orientation – The process of creating a budget takes management away from its short-term, day-to-day management of the business and forces it to think longer-term. This is the chief goal of budgeting, even if management does not succeed in meeting its goals as outlined in the budget – at least it is thinking about the Organization’s competitive and financial position and how to improve it.
- Profitability review – It is easy to lose sight of whether the Organization is making most of its money, during the scramble of day-to-day management. A properly structured budget points out what aspects of the business produce money and which ones uses it, which forces management to consider whether it should drop some parts of the business, or expand in others.
- Assumptions review – The budgeting process forces management to think about why the Organization is in business, as well as its key assumptions about its business environment. A periodic re-evaluation of these issues may result in altered assumptions, which may in turn alter the way in which managements decides to operate the business.
- Performance evaluations – You can work with employees to set up their goals for a budgeting period, and possibly also tie bonuses or other incentives to how they perform. You can then create budget versus actual reports to give employees feedback regarding how they are progressing toward their goals. This approach is most common with financial goals, though operational goals can also be added to the budget for performance appraisal purposes.
- Funding planning – A properly structured budget should derive the amount of cash that will be spun off or which will be needed to support operations. This information is used by the treasury section to plan for the Organization’s funding needs.
- Cash allocation – There is only a limited amount of cash available to invest in capital equipment and working capital, and the budgeting process forces management to decide which assets worth investing in.
- Bottleneck analysis – Nearly every Organization has a bottleneck somewhere, and the budgeting process can be used to concentrate on what can be done to either expand the capacity of that bottleneck or to shift work around it.
Well if the budgeting exercise is not providing the Organization with above benefits then there is something fundamentally wrong in the process. To understand where the problem lies one needs to ask the following questions from those leading the budgeting process:
- Are we seeking the right level of details at the right time?
- Is there lengthy instruction packs involved in the process – which never gets read?
- Are the assumptions used in the preparation of the budgets appropriate?
- Are the requirements based on needs or wish list?
- Does cross functional collaboration exists in the Organization? Are the goals of all departments of the Organization in line with the overall vision of the Organization?
- Are the managers appropriately trained to understand the budgeting requirement of the Organization?
Despite its challenges and issues, virtually no major Organization can evade the budgeting cycle. There is too much value in the end result to run a business without a financial plan. Budgets are fundamental strategic tools for delegating authority throughout an Organization, ensuring that managers clearly understand the quantifiable parameters used to judge their performance. In addition, for many Organizations, the budget routinely serves as foundation for periodic forecasts.
Hence in most cases the option of escaping the budgeting process is out of question though proper planning is required to manage the budget preparation process to make it thorough but without making the exercise long and tedious.