5.06 – Deciding Where Your Budgeting Process Starts
Creating a budget is more of an art than a science, much like accounting itself. It’s essential to be creative and flexible when preparing projections. Before diving into your first budget, follow these four key steps:
1. Delve into Your Business’s Financial History
Having a solid understanding of your company’s past financial and operating results is crucial. While new businesses might not have extensive histories, any available information should be clear and well-understood. Without a good grasp of this data, creating a budget would be ineffective. Keep in mind that while historical data provides a foundation, it isn’t always a precise predictor of future performance.
2. Involve Key Management
Budgeting is a vital function within the accounting and financial departments, as these are the people who best understand the numbers. If your business has multiple departments or sections, involve the respective managers in the process. Although financial and accounting teams produce the final budget, they rely heavily on data from various sources like marketing, manufacturing, and sales. Including all relevant parties ensures the most reliable information is used.
3. Gather Reliable Data
Quality market, operational, and accounting data form the basis of a good budget. Much of this data often comes from internal sources. For instance, when a sales region prepares a budget, the sales manager might survey direct sales representatives to gauge customer demand for the upcoming year. This helps determine sales volumes, personnel levels, wage rates, commission plans, and more.
While internal data is valuable, external data is equally critical. Access to quality and reliable external third-party information is essential for comprehensive business planning and reliable forecasts. Market forces and trends could impact your business over the next 24 months, and these might not be reflected in last year’s results.
4. Coordinate Budget Timing
Typically, companies start the budgeting process for the next year in the fourth quarter of the current year. This timing allows access to recent financial results to support the budgeting process. The goal is to have a sound budget as a foundation for the next year’s operations.
A general rule to follow: the nearer the term covered by the projection, the more detailed the information should be. For the coming fiscal year, monthly financial statement forecasts are expected with detailed support. For projections two or three years out, quarterly financial statement projections with more summarized assumptions are sufficient.
Key Considerations for a Successful Budget
The principle of “garbage in, garbage out” applies to budgeting. Without accurate and reliable data, the resulting budget will be of little value. Ensure the data used is as complete, accurate, reliable, and timely as possible. Although predicting the future perfectly is impossible, dedicating proper resources to gather quality information is essential.
Finally, ensure that projections align with the overall business plans and strategies. Remember, budgeting is a dynamic process that must adapt to changing market conditions. What worked two years ago might not provide the necessary information for today’s business decisions.
