Budgeting: Why and How
Basic definition: A budget is a plan that indicates the amounts of money that will be spent and the time at which those funds can be disbursed. A budget may also include incomes, though that tends to be less common for most managers. A budget general complements (or is an appendix to) a plan, which is a written document describing activities.
Who Uses Budgets?
Primarily, a budget is created for the manager and work team as a working document to measure and track the project.
The manager's managers also use the budget to track progress. Generally, middle and top management spend a significant portion of their time monitoring the activities of their subordinates, and budgets provide a convenient way to keep on top of them, as it's easier to keep an eye on the money than monitor activities.
The finance department, being responsible for managing the assets of a business, will also use budgets to help them predict the need for liquid assets. The sum of a company's various budgets becomes a roadmap for finance.
The accounting department, being responsible for tracking all financial transactions, will keep an eye on budgets. They tend to be regulators within a company and keep an eye out to ensure funds are used for authorized purposes.
The human resources department will track budgets, with particular attention to the line-items where cost is derived from labor. The (proper) role of HR is helping managers obtain the talent they need to accomplish their goals at a reasonable cost.
Eight Steps to Create a Budget
The author suggests that this will be a quick overview of the budgeting process, and the steps will be discussed in greater detail in the chapters that follow.
He notes that there are two starting points for a project: looking at the past (what was done in similar instances) and the future (what will need to be done in this instance). The nature of the project - whether its' a routine operation, similar to something, or totally new for the company - will determine which approach is applicable and will produce better results.
For the example, the author will develop an expense budget for a business unit based on the previous year's data.
- Gather Information. Find out what was spent in the past, but more importantly, find out why. A budget is based on events, and if the nature of events is changing (an increase or decrease in activity), it's not sufficient to simply carry forward the numbers.
- Review Line-Items. In order to draw out relevant information, it will probably be necessary to scrutinize the line items rather than the bottom line, and to seek out the information behind some of the line items.
- Make Predictions. The future will be different from the past, so the numbers cannot be carried forward without scrutiny. Materials and labor may costs more, some items may not be needed every year, you may identify substitutions, etc.
- Consider Major Amounts and Variances. Review the total budget and compare it to the previous year's actual amounts. Of particular importance are items with a high dollar amount or a larger variance from the previous year: it is likely these will be questioned, and you'll need to provide answers.
- Sweat the Small Stuff. There may be numerous small items that, when totaled, add up to a large amount. It's not uncommon to adjust the remainder of the budget proportionally, though that may not be appropriate. The larger the bottom-line amount, the more likely others will niggle.
- Document Assumptions. A budget that predicts future expenses assumes that certain things will remain true: the volume of activity and costs of supplies will be at a certain level, equipment will need only a certain amount of maintenance and repair, etc. Documenting them in advance helps to justify budget variances when unexpected things occur.
- Check Your Work. It's important to check the budget for mistakes, primarily mathematical, but even grammatical errors. Apparently, this problem is widespread enough that it's worth including as a step in the formal process rather than an assumption.
- Delivering the Budget. Generally, a budget must be reviewed and approved by a number of stakeholders before it will be authorized. The budget will usually need to be presented, in varying degrees of formality, to of the individuals and departments listed as an "audience" above. The different areas may have different requirements for how it should/must be presented to them to suit their needs.
Success Review
The author lists four qualities of a "good" budget:
- It is written clearly, so that it can be understood
- It is based on reliable information
- It is based on actual expenses, adjusted for future expectations
- It explains the rationale behind the numbers, particularly those that are likely to be questioned.
Typically, a budget will undergo a trial by fire and will need to be revised several times before it is ultimately approved. The more work done in advance, the less that will be needed in arrears - and the more competent the manager will seem.