Budgeting

by John Kind

In a nutshell

1. What is a budget?

A budget is a short-term plan, typically for a 12-month period. If the budget is for a business or organisation, it can be broken down into budgets for smaller organisational units. The financial aspects of a budget tend to receive particular attention, but the ‘non-financial’ aspects are also important. These non-financial aspects include customer satisfaction levels, market share objectives, staff retention rates and health, safety and environmental targets.

  • The budget preparation process should be seen as a genuine opportunity to review and improve performance, albeit under a tight schedule.
  • There should be clear links between the budget (short term) and longer-term plans, since the achievement of targets during the next budget period will help an organisation, department or team to achieve its longer-term ambitions.
  • The budget for a complete business or organisation is sometimes referred to as the ‘master’ budget. It will include revenues and sales, costs, the budgeted profit-and-loss account or income statement for the budget period, cash inflows and outflows, changes in short-term assets or resources, changes in both short- and longer-term obligations or liabilities and important financial performance measures.

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2. Why budget?

There are at least four reasons why it is important to budget:

  1. It’s essential to plan in a systematic way rather than just react to circumstances and situations as they arise
  2. To coordinate different activities and ensure that the overall business plan will be financed
  3. To make sure that each member of staff in your department, section or team is clear about what is expected of them during the next 12 months, following a genuine process of consultation
  4. To control and evaluate performance during the course of a financial period.

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3. The best way to prepare a budget

Whether you have budget responsibility for an entire business or organisation, a department, a function such as human resources, a section or a team, there are ten stages to complete:

  • Forecast results for the current budget period
  • Identify priorities for next budget period
  • Convert priorities into specific, measureable objectives for next budget period
  • Brainstorm ways to achieve budget objectives
  • Prepare detailed, initial budget proposals
  • Present initial budget proposals
  • Expect proposals to be challenged and revise them if necessary
  • Agree and get approved final version of budget
  • Communicate budget objective to colleagues
  • Monitor results as budget period gets underway.

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4. Forecast current period

A forecast is your best assessment or prediction of what your results are likely to be for the whole of the current year. It is essential to forecast the current period’s results. Otherwise, you will have no foundation or platform for thinking about the next budget period.

  • Step a: consult your team’s budget for the current year.
  • Step b: review YTD (Year To Date) performance. This can be done by analysing your Cost Report for the nine months ended, say, 30 September.
  • Step c is about taking corrective action to get you back ‘on track’ and estimating the financial impact of those measures.
  • Step d – prepare a cost forecast for the 12-month period of the current budget.

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5. Identify priorities

Having prepared your forecast for the current financial period, the next task is to specify the budget priorities for your business, department, organisation or team for the following year.

  • Will any changes in legislation, such as rules concerning maternity and paternity leave, affect your department or team?
  • What is the outlook for inflation, especially with regard to those costs that will affect your budget?
  • You need to indicate, as specifically as possible, the steps you will take next year to help the organisation achieve its longer-term objectives.

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6. Convert priorities to objectives

Based on the ways in which the external and internal issues will affect your organisation, they should be converted into specific and measurable objectives for next year (in other words, the next budget period). For example:

  • Revenue should increase by 8 per cent in the next budget year
  • Three new products should be introduced by the third quarter of the year to minimise the threat from a major competitor.
  • Costs, overall, should rise by no more than 4 per cent.

As a Departmental Head, Manager, Section Head or Team Leader, your task is to convert these organisational guidelines into specific and measurable objectives for your own budget for next year.

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7. Brainstorm

You need to produce a budget with costs below the permitted maximum. Your task is to explore the ways in which this can be done so you demonstrate your team’s commitment to greater efficiency and productivity. You and your colleagues will need to do some brainstorming:

  • Experiment with Zero-Based Budgeting (ZBB)
  • Be open-minded – invite colleagues to make suggestions
  • Challenge your cost levels
  • Focus on the 80:20 principle
  • Invite feedback from colleagues in different parts of your organisation
  • Explore ‘what if’ scenarios – the financial impact of different budget options.

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8. Initial detailed budget

Based on the ideas emerging from your brainstorming sessions, you can now prepare a detailed, initial budget. This initial budget will be your first, formal budget proposal for next year. At this stage, too, you may have to ‘calendarise’ the budget. That is, you now break it down into shorter budget periods so that, for example, you will have budgeted figures for calendar months or four-weekly periods.

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9. Present, revise, agree and communicate

You are now about to finalise your budget.

  • Be prepared to present your initial budget to your senior colleagues, both in writing and verbally, ensuring that your assumptions are made clear, the risks attached to achieving the budget are identified and KPIs highlighted.
  • Your initial budget submission is likely to be challenged during a series of budget meetings, so you may have to reconsider all or some of your proposals.
  • Eventually, you must make sure that your budget proposals are agreed and formally approved or ‘signed off’.
  • You then make sure that everyone in your team knows what is expected of them, individually and collectively.

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10. Monitor results

Make sure that you discuss and agree on a process that will allow you to consider your actual results against budget once the new budget period starts. You will need to analyse your team’s financial performance regularly. For example, at a monthly team meeting called, specifically, to

  • Review your team’s results
  • Discuss and agree on any corrective actions that will help to ensure that, for the rest of the budget period, your performance will be as close to budget as possible.

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11. Budgeting in the public sector

The details of the spending review announced by the government in October 2010 indicate that, over the next four financial years, there will be no increase in public expenditure after allowing for inflation. As a consequence and as the Treasury highlighted, a complete re-evaluation of the public sector’s role in providing services is required.

The budgeting task in the public sector can be even more demanding than in the private sector.

  • It can be difficult to define the relationship between inputs and outputs.
  • A much more wide-ranging stakeholder engagement process is required. As well as the staff directly involved, many other interested parties need to be consulted.
  • Traditionally, public sector budgeting has relied on the ‘incremental approach’. This means that the previous year’s budget is carried forward to the next budget round.
  • Public sector budgeting is now moving to a zero-based budgeting approach.

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12. The ZBB approach

A typical checklist of the questions to ask when carrying out ZBB would be as follows:

  1. Is the activity really necessary?
  2. What will happen if the activity stops?
  3. What are the different ways of carrying out the activity?
  4. How much should the activity cost?
  5. Do the benefits gained from the activity match its costs?

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