The budgeting process is usually rife with delays, which are caused by several factors. One is that information must be input to the budget model from all parts of the company—some of which may not put a high priority on the submission of budgeting information. Another reason is that the budgeting process is highly iterative, sometimes requiring dozens of budget recalculations and changes in assumptions before the desired results are achieved.
The typical budgeting process is represented in below flow chart, where we see that there is a sequential process that requires the completion of the revenue plan before the production plan can be completed, which in turn must be finished before the departmental expense budgets can be finished, which then yields a financing plan. If the results do not meet expectations, then the process starts over again at the top of the exhibit. This process is so time-consuming that the budget may not be completed before the budget period has already begun.
There are a number of best practices that can be used to create a more streamlined budgeting process, which are as follows:
- Reduce the number of accounts. The number of accounts included in the budget should be reduced, thereby greatly reducing the amount of time needed to enter and update data in the budget model.
- Reduce the number of reporting periods. Consolidate the 12 months shown in the typical budget into quarterly information, thereby eliminating two-thirds of the information in the budget. If the budget must later be reentered into the accounting system in order to provide budget-to-actual comparisons, then a simple formula can be used to divide the quarterly budget back into its monthly components—which is still much less work than maintaining 12 full months of budget information.
- Use percentages for variable cost updates. When key activities, such as revenues, are changed in the budget model, one must peruse the entire budget in order to determine what related expenses must change in concert with the key activities. A much easier approach is to use percentage-based calculations for variable costs in the budget model, so that these expenses will be updated automatically. They should also be color-coded in the budget model, so that they will not be mistaken for items that are manually changed.
- Report on variables in one place. A number of key variables will impact the typical budget model, such as the assumed rate of inflation in wages or purchased parts, tax rates for income, payroll, and worker’s compensation, medical insurance rates, and so on. These variables are much easier to find if they are set up in a cluster within the budget, so that one can easily reference and alter them. Under this arrangement, it is also useful to show key results (such as net profits) on the same page with the variables, in order to make alterations to the variables and immediately see their impact without having to search through the budget model to find the information.
- Use a budget procedure and timetable. The budget process is plagued by many iterations, since the first results will nearly always yield profits or losses that do not meet a company’s expectations. Furthermore, it requires input from all parts of a company, some of which may lag in sending in information in a timely manner. Accordingly, it is best to construct a budgeting procedure that specifically identifies what job positions must send budgeting information to the budget coordinator, what information is required of each person, and when that information is due. Furthermore, there should be a clear timetable of events that is carefully adhered to, so that plenty of time is left at the end of the budgeting process for the calculation of multiple iterations of the budget.
In addition to these efficiency-improvement issues, there are other ways to modify the budgeting process so that it can be completed much more quickly. The following changes should be considered:
- Preload budget line items. Rather than requiring department managers to fill out a blank budget form for the upcoming budget year, have the accounting staff preload many of the budget line items with information from the current year. Most expenses are relatively fixed from year to year, or are easily linked to key drivers, such as headcount. Consequently, the accounting staff can probably arrive at more accurate budget numbers than a department manager for most line items. This approach leaves only a few of the larger and more variable accounts for managers to enter in the budget form. In some cases where a department is anticipating no major changes for the next budget year, it may even be possible for the accounting staff to create the entire department budget, so the department manager has only to make revisions to it.
- Itemize the corporate strategy. The strategy and related tactical goals that the company is trying to achieve should be listed at the beginning of the budget model. All too frequently, management loses sight of its predetermined strategy when going through the many iterations that are needed to develop a realistic budget. By itemizing the corporate strategy in the budget document, it is much less likely that the final budget model will deviate significantly from the company’s strategic direction.
- Identify step-costing change points. The budget model should have notations incorporated into it that specify the capacity levels at which expenses are valid. For example, if the production level for product A exceeds 100,000 per year, then a warning flag should be generated by the budget model that informs the budget manager of the need to add an extra shift to accommodate the increased production requirements. Another example is to have the model generate a warning flag when the average revenue per salesperson exceeds $1,000,000, since this may be the maximum expectation for sales productivity, and will require the addition of more sales personnel to the budget. These flags can be clustered at the front of the budget model, so that problems will be readily apparent to the reader.
- Specify maximum amounts of available funding. One of the warning flags just noted should include the maximum level of funding that the company can obtain. If an iteration of the budget model results in excessively high cash requirements, then the flag will immediately point out the problem. It may be useful to note next to the warning flag the amount by which the maximum funding has been exceeded, so that this information is readily available for the next budget iteration.
- Base expense changes on cost drivers. Many expenses in the budget will vary in accordance with changes in various activities within the firm. As noted earlier in this section, expenses can be listed in the budget model as formulas, so that they vary in direct proportion to changes in budgeted revenue. This same concept can be taken a step further by listing other types of activities that drive cost behavior, and linking still other expenses to them with formulas. For example, the amount of telephone expense is directly related to the number of employees, so it can be linked to the total number of employees on the staffing budget. Another example is the number of machine setup personnel, which will change based on the planned number of production batches to be run during the year. This level of automation requires a significant degree of knowledge of how selected expenses interact with various activities within the company.
- Budget by groups of staff positions. A budget can rapidly become unwieldy if every position in the company is individually identified—especially if the names of all employees are listed. This format requires constant updating as the budget progresses through multiple iterations. A better approach is to itemize by job title, which allows one to vastly reduce the number of job positions listed in the budget.
- Rank projects. A more complex budget model can incorporate a ranking of all capital projects, so that any projects with a low ranking will be automatically eliminated by the model if the available amount of cash drops below the point where they could be funded. However, this variation requires that great attention be paid to the ranking of projects, since there may be some interrelationship between projects—if one is dropped but others are retained, then the ones retained may not be functional without the missing project.
- Issue a summary-level model for use by senior management. The senior management team is primarily concerned with the summary results of each department, product line, or operating division, and does not have time to wade through the details of individual revenue and expense accounts. Further, they may require an increased level of explanation from the budgeting staff if they do choose to examine these details. Accordingly, the speed of the iteration process can be enhanced by producing a summary-level budget that is directly linked to the main budget, so that all fields in it are updated automatically. The senior management team can more easily review this document, yielding faster updates to the model.
- Link budget results to an employee goal and reward system. The budgeting process does not end with the final approval of the budget model. Instead, it then passes to the human resources department, which uses it as the foundation for an employee goal and reward system. The trouble is that if budget approval is delayed, the human resources department will have very little time in which to create its goal and reward system. Accordingly, this add-on project should be incorporated directly into the budget model, so that it is approved alongside the rest of the budget. For example, a goals and rewards statement added to the budget can specify a bonus payment to the manager of the production department if he or she can create the number of units of product specified in the production budget. Similarly, the sales manager can receive a bonus based on reaching the sales goals noted in the revenue budget. By inserting the bonus amounts in this page of the budget, the model can automatically link them to the final targets itemized in the plan, requiring minimal further adjustments by the human resources staff.
As a result of these improvements, the budgeting process will change to the format shown in the above flow chart, where the emphasis moves away from many modeling iterations toward the incorporation of a considerable level of automation and streamlining into the structure of the budget model. By following this approach, the budget will require much less manual updating; this will allow it to sail through the smaller number of required iterations with much greater speed.