How to budget

Writing the budget might not be the most exciting of jobs, but it’s crucial for the survival of every business and the success of every department. Scott Beagrie shows us how to crunch the numbers

The vast majority of decisions taken in the world of business, the public sector and not for profit organisations have a financial impact. Effective stewardship of organisational costs and revenue is critical, especially in the current economic climate when attention is more keenly focused on finances, and this is where the annual budget comes in.

But even highly competent managers sometimes lack confidence when it comes to budgeting. Davide Sola, professor of strategy and management at ESCP Europe Business School, suggests this is because managers often regard budgeting as belonging to management control or finance departments rather than as a tool used by most organisations for managing performance, monitoring progress and business success.

But a thorough understanding of the budgeting process must be seen as part of the remit of all managers, especially as organisational structures become flatter and more devolved. When setting a budget you are effectively fleshing out the business plan with workable figures. While the budgetary process is relatively mechanical and can be learnt, it does call for thought, time and patience. You may not get it all right first time but the more times you do it, the more proficient and confident you’ll become.

Determine strategic plan priorities

Rigorous preparation will help improve the accuracy of the budget so be sure to set aside ample time to think the numbers through, plan and draw it up. A rushed budget, or one carried out to meet unrealistic deadlines, will force you to make potentially disastrous assumptions. Collate all relevant data and information such as last year’s budget sheets, unit costs of product lines and capital expenditure for equipment. Undoubtedly some budgets will be more complex than others but in the main you should concern yourself with three main areas: profit and loss (P&L), the balance sheet and cashflow. Before starting out, formulate a clear picture of these.

Mistakes can be avoided by discussing assumptions with the relevant people. Sharing will also increase the buy-in. Constructively challenge each assumption both in terms of value (unit sales) as well as distribution over time – in other words, the ramping up of unit sales

Davide Sola, professor of strategy and management, ESCP Europe Business School

It is imperative that the budget and thinking behind it links clearly to your strategy. Check that the aims and targets of each business unit or department are both aligned with and reflected in the budget.

Remember that the budget exists to help the organisation meet its aims as well as provide internal control. When operating in adverse economic conditions it can be difficult to put strategy before money, but by doing so you could encourage innovation.

Sola also points out that thinking of cost in isolation and not how it relates to revenue could turn out to be a false economy: for instance, detracting from the quality of a product and consequently the ability to raise its price.

Approaches to budgeting

Generally there are two routes to budgeting: zero-based budgeting, which starts a budget ‘from scratch’ taking zero as a start-point, and incremental budgeting (sometimes called budget plus), which adjusts the budget from the previous year’s figures to allow for factors such as inflation and growth.

Increasingly, experts warn of the potential hazards of incremental budgeting. It fails to question assumptions, trends are not picked up and if mistakes are made in the previous year, or years’ figures, the effect is compounded annually.

Budgets must also allow for unexpected factors including new competitors emerging or old ones dropping out of the market, and new processes being introduced, which may be more streamlined and therefore more cost effective.

Share the process

Setting a budget should not be a solo effort and it will be more realistic and achievable if you involve other relevant managers. Getting early cooperation from all stakeholders will increase the chances of the budget being viewed as a useful tool, speed up the approval and sign off process. “Share, share and share with the top team as well as with everyone involved in each driver,” says Sola. “Mistakes can be avoided by discussing assumptions with the relevant people. Sharing will also increase the buy-in. Constructively challenge each assumption both in terms of value (unit sales) as well as distribution over time – in other words, the ramping up of unit sales.”

Relevant managers should also be included in any risk analysis on the budget and determining whether contingency needs to be built in.

Monitor and evaluate

A common mistake is to complete the budget, get it signed off and then file it away for 12 months. A budget needs to be constantly monitored, reviewed and assessed in the light of the organisation’s performance throughout the year

Where serious deviations arise, seek input from those individuals with a vested interest and react quickly to adjust or reallocate funds where appropriate.

At the end of your financial year, assess how the budget performed – was it realistic? Did it have to be adjusted? Did it enable the organisation to meet its aims? And before you start planning for the new financial year, look at what lessons can be learned for next time.