Hands up all of you who love budgeting! Hmm – thought so! So do you view it as a necessary evil or does the very word fill you with fear and dread? I hope, for your sake, it’s not the latter!
However whenever I ask participants what is the purpose of a budget, no one seems to have a problem listing a number of points such as:
- Sets a direction
- Allows planning and coordination
- Allocates resources – which may be scarce (I am still looking for an organisation where they are not!)
- Allows review, monitoring and control
- Can identify problem areas early
- Assigns responsibility and accountability
After all the budget is nothing more than a financial plan and we all know the old adage – Poor Planning and Preparation leads to P** Poor Performance!
So when you think of budgeting – what do you think of?
One COO wanted me to not use the word budget in running training for their company. Why? Well his view was that budgeting had become synonymous with the annual budget setting process and was not seen as a continuous process. He preferred to call it business planning and to emphasise that it should be a continuous process – part of continuous improvement.
This of course picks up on the implementation of the budget and the reporting of actual performance. The closed feedback loop means that there is a continuous review of actual performance, identification of areas for improvement, opportunities and indeed corrective action.
What does amaze me is when I come across the ‘annual budget setting’ process taking place a month or so before the strategic planning. Surely the budget is a subset of the business plan and therefore needs to be aligned to the strategic plan? Otherwise how are we ensuring that those scarce resources are being allocated in line with our key strategic objectives?
So if you are faced with the prospect of setting a budget, where do you start?
If this is the first time you have been asked to do this, it can be quite daunting. Please take comfort in the fact that this is a plan and unless you happen to have a crystal ball, you are never going to get it exactly right! (BTW if you do have a crystal ball, can you send me one please?) However if you have been asked to draft the budget, it is because you are viewed as the person who knows most about your area and are therefore the best person for the job.
There are a number of different ways to assemble budgets and the approach which is used most often is referred to as historical, incremental or base line budgeting. (Forgive the financial jargon – I am just the messenger here!)
If I describe this approach, you will recognise it. It involves taking your latest actuals/forecast numbers for the current period and using this as the starting point for next year’s budget, then factoring in the likely changes. These changes will obviously include such things as CPI, identifying one off items which happened this year and are not likely to be repeated, as well as planned changes in processes, personnel or equipment.
Understanding the business, revenue and cost drivers for your area will be key to this. When we refer to the drivers they are the things that cause the cost or the income to arise? For example, how would your budget be affected by changes in say, Government, economic conditions or environmental changes? Do you know the events which have the most impact on your figures?
Also always bear in mind that we are preparing a budget as part of strong financial management. So a budget should not be a stretch target. It should be a realistic view of what can be achieved – more of that later!
A really useful management principle should come into play here – the Pareto principle! Whilst your area’s budget may have many lines, it is likely that 20% of lines account for 80% of the dollars! Focus on the key areas. If yours is a cost centre then it is almost certain that one of your major costs with be the employment costs.
So what are the cost drivers for employment for next year? It is going to be made up of the number and levels of personnel as well as the salaries/wages rates. Are you likely to recruit staff, is there an EBA agreement, are there changes in employers’ superannuation contributions etc.?
Spending your time to research and consult on your big ticket items will hopefully give you confidence that you have done the best job you can. You may have 3 or even 5 key items. Focus your attention on these. You do not need to or should spend as much time researching the other items which probably only account for 20% of the dollar amounts.