5.08 – Preparing an Actual Budget vs a Forecasted Budget
When preparing a budget, it’s essential to start with a draft that is summarized and focused on the financial statement. This helps create a general format or framework that captures the basic output desired by those using the budget. By offering a summarized visual version, reviews and edits can be made before diving into detailed specifics. Once the desired output reports and data points are determined, the budget can be expanded and adjusted to incorporate the correct level of detail.
Summarized Budgets
A summarized budget is both flexible and adaptable, making it easier to build and modify as needed. Software like Excel is highly recommended for creating these models due to its user-friendliness and wide acceptance in the business world.
Starting with the Income Statement
For most companies, the budgeting process begins with producing a projected income statement for several reasons:
- It’s the most widely used and easily understood financial statement.
- It acts as a base data point for producing balance sheet and cash flow statements.
- The majority of the data needed for budgeting is centered around the income statement, such as sales volumes, pricing, and staffing requirements.
Consistency with Current Financial Statements
Budgets should be prepared in a format consistent with the company’s current financial statements. This ensures conformity and makes it easier to understand and utilize the budget. For instance, a budget for XYZ Wholesale, Inc. might look something like this:
Key Elements of a Summarized Budget
Historical Financial Information
Include the most recent year-end financial data as a base reference. Understanding past performance is crucial for accurate forecasting.
Complete Financial Projections
Ensure the budget includes projections for the income statement, balance sheet, and statement of cash flows. This comprehensive approach provides a full financial picture.
Quarterly Information
While monthly projections can provide more frequent data, quarterly projections are often sufficient for a summarized budget. This lesson uses quarterly projections as an example.
Summary Format
Present the budget in a summarized format, combining detailed data into single line items. For example, sales from multiple locations can be rolled up into one line item in a company-wide forecast. This format is ideal for external reviews and managerial oversight.
Highlight Key Economic Drivers
Identify and emphasize critical business factors in the projection model. For example, improvements in gross margin or significant changes in pretax net income should be clearly noted. These highlights can help management make informed decisions and identify trends.
Confidentiality and Audit Status
Clearly state that the information is confidential and unaudited. This is important for maintaining the integrity and security of the data.
Practical Tips for Budget Preparation
Dive In and Start
The best way to prepare your first budget is to start drafting it. The initial draft will likely undergo many revisions, but it’s easier to improve something that already exists than to create it from scratch.
Iterative Process
Expect your first draft to change significantly. Use feedback to refine, expand, and enhance the budget, making it a more valuable tool for managing your business.
Flexibility and Adaptability
Ensure the budget model you create is flexible enough to accommodate changes and adapt to new information or business conditions.
By following these guidelines, you can develop a robust budget that serves as an essential tool for managing your company’s financial health and strategic planning.
