What is a Budget and What is Budgeting?
Budgeting is the process that leads to a budget. A budget is a financial plan and forecast for the company's economic events.
How Budgeting Works
The budget is typically linked to a time period (such as a fiscal year) and is often built based on the organisation's departments or business areas. The budget is a plan for the organisation's expected outcomes during the period it covers. The budget includes both revenues and costs, but it can also include investments and cash flow.
Budgeting also correlates with key performance indicators (KPIs) and goals set for various parts of the operation. These goals are tied to the company's strategy and business plan, and the allocation of the budget should help the business reach its objectives.
A budget consists of three parts that need to be budgeted:
1. The performance budget is most commonly what is budgeted and thus often what is referred to as "the budget". The income budget consists of the company's revenues and costs. The purpose is to calculate and control the company's revenues and costs.
2. The liquidity budget (cash budget) deals with the company's liquidity (liquid assets). The liquidity budget reflects the company's payment ability over a period. This means that the liquidity budget shows whether the company has "actual money" to pay out and what is coming in.
3. A budgeted balance sheet shows how assets, equity, and liabilities are expected to evolve over the period that is budgeted.
Main Budget, Sub-Budget, and "A single source of truth about costs"
Income, liquidity, and budgeted balance sheets are main budgets and are built up of sub-budgets that are summarised. Examples of sub-budgets include budgets built up per department or business area, such as a sales budget. The total budget consists of all sub-budgets. Other examples of sub-budgets are cost budget, staff budget, overhead budget, and capital budget.
According to a minor survey by McKinsey, the majority of managers (57 percent) are dissatisfied with the transparency of administrative and general costs.
Of those who are satisfied (43 percent), the main source of satisfaction was advanced software that served as a single source of truth about costs. Does this resonate with your experience?
Different Budgeting Methods
In the budgeting process, there are many methods to choose from, where factors such as the type of business, corporate culture, and previous experiences can come into play. Examples of different budgeting methods include:
Account-Based Budget: In the Account-Based Budget, the structure of the planning work is based on the chart of accounts, which is the list of all the accounts the company uses for its accounting. This is the traditional way of conducting Financial Planning.
Driver-based budget: With a driver-based model, the company plans based on concepts close to operations. This can involve factors like the number of products sold, occupancy rate, or volume. The key is that the 'drivers' are concepts important to the operation and that the employees can understand and adopt.
Rolling Budget (Rolling Forecast): Gives you a continuous picture over the forecast's time window (the period you're looking at). The budget/forecast "rolls" forward while a traditional forecast ends at a specific point in time (usually the end of the fiscal year).
When the budget is reworked, you instead look (for example) 12 months ahead. Rolling forecasts are more flexible than other forms of budgeting and help companies look ahead, based on where they stand today.
Top-Down Budget: Management develops an overall budget for the entire company based on the company's business goals and possibly previous budgets. The budget is then distributed, for example, among the company's departments.
Bottom-Up Budget: The budget is built from the bottom up and compiled into a total budget. This could be based on the organisational structure where different departments set their own budget. Management approves the budgets and may request adjustments until a final budget is in place. This can mean that several versions of the budget are created and processed before a final budget is approved.
Zero-Based Budgeting: Here, departments must continuously justify their budget (and their costs). Nothing is assumed to be included for the next budget period. The idea is for the company to become more cost-conscious and for managers to start from what is necessary for the upcoming budget period.
Some of these methods are grouped under concepts like 'Beyond Budgeting', also known as 'budgetless control', where work is done more agilely and based on a collection of management processes and principles. Often, this involves working with a rolling forecast.
Budgeting and Financial Control
Budgeting is closely linked with Financial Control and Strategic Planning because money is a prerequisite for what the company does, and the distribution of money is thus a way to manage and influence the operation.
Budgeting also provides financial information to stakeholders about the company's financial position. It can thus be a control tool that contributes to security, motivation, and transparency.
The data and insights you have related to your company's financial position should be quality assured, accessible to everyone involved in the budgeting, and ideally visualised in a way that facilitates understanding.
Actively monitoring how the operation performs relative to the budget (budget follow-up) allows you to see if goals are being met (how it turned out), and cash flow calculations ensure that you have enough money. It's also a good idea to work with scenario planning in your budgeting process, and your work is facilitated if you have software in place that can handle this.
Budget as a Tool
In financial control work, it's advantageous to continuously analyse the operation in relation to the budget, in order to identify and act on any deviations (the difference between budget and outcome).
View budgeting as a tool that supports decision-making and economically follows up on business results. Follow up on budget outcomes, liquidity, profitability, solidity, and act on deviations.
Also, bear in mind that a budget that is too detailed can become cumbersome and thus less useful as a tool. The budget should be prepared at the lowest possible level, thereby staying close to the operations.
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