Budgeting

by John Kind

Forecast current period

Forecast the results for the whole of the current budget period, such as the current calendar year. This should be done before you start preparing the budget for the following year – the next budget period. 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.

A forecast is your best assessment or prediction of what your results are likely to be the whole of the current year, bearing in mind

  • Your actual performance, so far, during the current year
  • The budget for the remainder of this year
  • The financial impact of the corrective actions to be taken during the remainder of the year.

This means that you should

  1. Consult the existing budget for the current year
  2. Review actual performance, so far, during this year. For example, you might have just received the actual and budgeted results for the nine months ended 30 September. Some items will be above budget. Others will be below budget. You will need to understand why these differences, or variances as they are called, have arisen.
  3. Take corrective action(s), as appropriate, to help to ensure that for this year, as a whole, your results will be as close as possible to the budgeted results for the year.
  4. Consider the budget for the remaining part of the financial year. In the case of the scenario described below, this will be for the three months ending 31 December.
  5. Prepare a forecast for the whole of the budgeted period (January – December) taking into account b, c and d, above.

These steps are described in the scenario below.

Scenario

The budget period is the current calendar year. You are a Team Leader in the IT Department. You were appointed in January, so you played no part in preparing the budget, but you do need to ensure that you achieve it. You are also aware that you will be responsible for preparing the next year’s budget!

Step a

Consult your team’s budget for the current year. The details are as follows:

Budgeted costs for January – December

Cost/expense
Budget
£000s
Team members’ salaries
239
‘Space’ costs
35
Systems development
60
Staff training
8
Travel and entertainment
11
TOTAL
353

Notes to the budget

  1. Team member’s salaries include pension contributions and health care costs. Apart from you, as Team Leader, there are five team members.
  2. ‘Space’ costs represent the proportion of the total rent, business rates and utility charges (such as electricity and telephone) allocated to your part of the IT department
  3. As a Team Leader, your budget is a ‘cost’ budget only. Your task is to ensure that actual costs turn out to be as close as possible to budgeted costs.

Step b

Review your YTD (Year To Date) performance. This can be done by analysing your cost report for the nine months ended 30 September, as shown below:

Type of cost/expense
Actual YTD
£000s
Budget
£000s
Actual as a % of budget
Team members’ salaries
153
161
95.0%
Pension contributions
22
23
95.7%
‘Space’ costs
29
26
111.5%
Systems development
49
45
108.9%
Staff training/recruitment
5
6
83.3%
Travel and entertainment
7
8
87.5%
TOTAL
265
269
98.5%

The total costs for your team are 1.5 per cent below budget after nine months of the current financial year. But this overall difference hides some important individual variances. You need to understand the reasons why these variances have occurred.

  • The cost of salaries and pension contributions are about 5 per cent below budget. Why? There may, for example, have been recruitment delays.
  • ‘Space’ costs are 11.5 per cent above budget. Why? The answer may be that your team now occupies more space than was budgeted.
  • Systems development costs are nearly nine per cent higher than budget. Why? The answer may be that there was a cost overrun on a particular project in view of unexpected (and unbudgeted) technical difficulties.
  • Staff training/recruitment and travel and entertainment are both more than 10 per cent below budget. This may be because the delays in recruitment have resulted in lower training costs and lower than expected travel and entertainment bills.

Step c

This is about taking corrective action to get you back ‘on track’ and estimating its financial impact. This will help to ensure that your team’s actual results for the whole of the year are as close to budget as possible. This corrective action, of course, was not part of the original budget.

The priorities are:

  1. To ensure that the ‘recruitment delay’ problem is sorted out
  2. To explore the possibility of using less office accommodation so that ‘space’ costs come more in line with the budget (introduce more ‘hot’ desking by allowing team members more time to work from home?)
  3. To take steps to make sure that the technical difficulties producing higher-than-budgeted system development costs during January – September are not repeated during the rest of the financial period (October – December).

These priorities involve incurring costs (priority 1 above) as well as making cost savings (priorities 2 and 3), so that they will have an impact during October – December.

Assume the following:

  • The ‘recruitment delay’ problem will be sorted out so that salary, training and recruitment costs for the three months ending 31 December are expected to be on budget
  • Introducing more ‘hot’ desks will save £3,000 during the October – December quarter
  • Minimising technical difficulties associated with systems development will save £4,000 during the same quarter.

This will mean that in the last quarter of the year, there will be total cost savings of £3,000 plus £4,000 to give £7,000, which were not, of course, included in the original budget.

Step d

This is about preparing a cost forecast for the current 12-month period, January – December as follows:

  • We know that actual costs for the nine months to 30 September were £265,000; we can do nothing about them – they are ‘sunk’
  • We know that budgeted costs for the 12 months ending 31 December are £353,000
  • We know also that budgeted costs for the nine months ended 30 September were £269,000
  • This means that budgeted costs for the three-month period from October to December are £84,000 (the budgeted costs for the whole year are £353,000, while the budgeted costs for the nine months to 30 September are £269,000)
  • If everything went according to budget during October – December, your forecast for the whole period would be £265,000 (actual total costs, January – September, plus the budgeted costs for October – December of £84,000). This gives £349,000. However, you expect to save £7,000 during the last quarter. This means that your total cost forecast will be £349,000 less £7,000 = £342,000. This is summarised in the table below.

Costs during the current year

 
Nine months to
30 September
Three months to
31 December
Financial impact of corrective action
Forecast for the current year
Actual
£000s
Budget
£000s
£000s
£000s
Salaries
175
55
-
230
‘Space’ costs
29
9
(3)
35
Systems development
49
15
(4)
60
Training
5
2
-
7
Travel/entertainment
7
3
-
10
TOTAL
265
84
(7)
342

Summary

Note

If you were responsible for planning the current year’s budget, you will in any case be regularly monitoring performance against budget.

The first stage in preparing a budget for your next financial period is to produce a forecast of what you think your results will be – what you expect to achieve – for the current financial period (in this example, the current year).

The forecast is the essential starting point. It is the basis on which the budgeting challenges for the next budget period, next year, can start to be identified, discussed and resolved.