Estimating your expenses and revenues helps you determine if you have sufficient cash to finance your activities and projects for the upcoming year, without a budget your business runs the risk of running out of cash and bankrupt. Although managers understand the significance of budgeting, implementation is not always smooth. Below we’ll outline a process to help you implement your budget effectively. An effective budget is less about having the finance department run spreadsheets and provide outputs to the organization; it’s more about a collaboration with department heads and getting everyone’s input.
The budget process is different from forecasting process. Budgeting is done annually and remains static, where forecasts are done more frequently and are more dynamic as they often change weekly or sooner.
Phase One - Planning
The initial phase is the planning stage where you plan your budgeting process and timelines. The timelines and dates are managed by the Finance Department and CFO.
• Create a schedule and project plan and assign responsibilities at the beginning of the process.
• Work backwards from target completion date to create the schedule, allotting sufficient time for department heads to provide their input.
• Detailed budget processes typically take between 60 and 120 days depending on the complexity of the business and the experience of the team involved.
Phase Two - Implementation
• Management team agrees on a strategic plan and key initiatives for the year.
• Based on strategy, create capital expenditures plan by department to meet objectives for the year.
• CFO and CEO should set a "top-down" target, and key assumptions, and share with teams.
• CFO and finance should initially gauge at this point if the "top-down" targets and capital spending targets are feasible from a cash flow standpoint.
• Department heads create detailed P&L budget for the line items for which they are responsible.
• Each department head meets with CFO and CEO to review details and explain department strategy and its expense needs.
• If the "bottoms-up" totals do not tie to the "top-down" targets, department heads are asked to revise and adjust accordingly. Compromises may have to be made and strategic priorities adjusted.
• Finance should also create a balance sheet budget for each version based on P&L, inventory targets and other KPI's to ensure adequate cash and/or financing will be available.
• Once the budgets are done, it is wise for Finance to sensitize the budget to ensure that the company can survive a "worst case" performance scenario.
• It is important that each department head takes ownership of their budget. Otherwise, they may feel it was just handed to them, and therefore, they cannot be held accountable. A budget without accountability going forward is not useful.
• Detailed budgets submitted by departments should be rolled up into total P&L.
• Version management and updating of master budgets is key and typically the responsibility of the finance department.
Phase 3 – Monitor & Review
• At each month end, Department heads are expected to explain any variances between actual results and the budget.
• It is crucial that budget variances be identified quickly after month end to allow department heads to take corrective action before they are too deep into the next month to have an impact.
It is important to remember that the budget process is iterative and numbers will change till an agreement is reached, all parties should come in with an open mind and realize that comprises will be required.
The above steps outline the traditional budget process; other variations exist such as a “rolling budget” where future budgets are updated on a regular basis (quarterly for example).