In order to make effective decisions and coordinate the decisions and actions of the various departments, businesses need to have a plan for profitability. Typically a business creates a budget annually which, once approved, becomes the Annual Plan (or Budget). The Budget serves several purposes:
- It is a means for Executive Management to gain consensus on how the year’s resources are going to be allocated towards realization of the companies quantifiable goals for the year.
- A Goal Setting Exercise.
- Provides a Metric for Assessing Company Performance.
- Acts as an Approval Process.
To be effective, the budget process should have several key components: Clearly Defined Goals, Effective Communication, Management Involvement, Coordination, and Actual Performance Reporting.
Clearly Defined Goals
The Financial Goals of the company need to be defined at the beginning of the process. A typical goal would be Revenue Growth at 20%, Net Income Growth of 10% and Departmental Operating Expense Growth at varying growth levels. Typically, depending on the company, each Division/Department has different growth expectations depending on the type of company. Businesses that have significant Research and Development activities, for example, usually allocate a larger amount to R&D expenses. The process of developing the goals begins with an analysis of the current year’s performance and an understanding of what relationships exist to Revenue, fixed and variable.
In order for the Management Team to be able to translate the Goals into an Operating Budget, effective communication is imperative. First, a timetable needs to be developed to set expectations and to determine deadlines. A company meeting to communicate the process is desirable to ensure everyone receives the same message. A budget package is distributed to management with information to help develop budgets. The package should contain a rolling forecast updated with actuals, employee detail for headcount planning, the defined goals with specifics related to each department, a digital worksheet to aid both the development of the budget and any upload or consolidation process, and a financial calendar which includes deadlines and responsibilities.
For the process to be effective, Management buy-in is essential both in the planning process and during the year to monitor and manage actual performance. One purpose of the budgeting exercise is to achieve consensus by everyone even though they are all competing for the same resources. It is not possible for everyone to be able to add all the headcount they desire or spend the amount of money they would prefer. In addition, each department has a different perspective on what is necessary to achieve the company’s goals and the importance of their contribution. By the end of the process, everyone will have had to compromise and should understand where their interests all intersect with the company’s goals.
Someone needs to be in charge of the process and drive towards the deadlines. It is common for it to fall within the Chief Financial Officer’s responsibilities. Absent that position, at the direction of the COO it usually belongs in the Controller’s responsibilities. Preparing the information for goal setting, creating the worksheets, consolidating the information and being available to facilitate the process are all responsibilities of this position.
Actual Performance Reporting
Important to the effectiveness of the process is regular comparison of actual performance to the budget. In addition to the inclusion of budgets in the financial statement comparisons, many decisions should be made with the budget in mind. For example, headcount additions and fixed asset acquisitions should be evaluated if they were not budgeted expenses. Many companies allow expenditures that were approved in the budget process but require extensive justification if they were not.
Done well, the budget process is an invaluable tool for our clients to monitor and achieve profitability. TGG Accounting can work closely with you and your management team to build effective budgeting tools. Call us today to get started.