The budgeting process
/A budget is used by a business to set expectations for revenues and expenses in future periods. The process of preparing a budget should be highly regimented and follow a set schedule, so that the completed budget is ready for use by the beginning of the next fiscal year. Otherwise, a late budget will not be available for the purpose of comparison to actual results in the next fiscal year. The basic steps to follow are noted below.
Step 1: Update Budget Assumptions
Review the assumptions about the company's business environment that were used as the basis for the last budget, and update as necessary. It is possible that some of the assumptions used the last time are no longer valid, which may have resulted in a budget that did not adequately represent the financial situation of the business.
Step 2: Note Available Funding
Determine the most likely amount of funding that will be available during the budget period, which may limit growth plans. This is a major item, since many budgets are developed using an unrealistic assumption regarding the amount of funding that will be available.
Step 3: Locate Step Costing Points
Determine whether any step costs will be incurred during the likely range of business activity in the upcoming budget period, and define the amount of these costs and at what activity levels they will be incurred. This is a critical point, since step costs can be enormous - such as the cost of adding more production equipment to meet a projected level of demand.
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Step 4: Create Budget Package
Copy forward the basic budgeting instructions from the instruction packet used in the preceding year. Update it by including the year-to-date actual expenses incurred in the current year, and also annualize this information for the full current year. Add a commentary to the packet, stating step costing information, bottlenecks, and expected funding limitations for the upcoming budget year. Also state any guidelines for capital budgeting requests.
Step 5: Issue Budget Package
Issue the budget package personally, where possible, and answer any questions from recipients. Also state the due date for the first draft of the budget package.
Step 6: Obtain Revenue Forecast
Obtain the revenue forecast from the sales manager, validate it with the CEO, and then distribute it to the other department managers. They use the revenue information at least partially as the basis for developing their own budgets.
Step 7: Obtain Department Budgets
Obtain the budgets from all departments, check for errors, and compare to the bottleneck, funding, and step costing constraints. Adjust the budgets as necessary.
Step 8: Validate Compensation
Send the compensation requests contained within the department budgets to the human resources manager for validation. This should include matching against pay ranges and ascertaining whether payroll taxes are being correctly calculated.
Step 9: Validate Bonus Plans
Have the senior management team validate the terms under which bonus plans have been arranged, and whether the conditions of those agreements are reasonable. If bonus payments are more likely than not to occur, include them in the budget, along with applicable payroll taxes.
Step 10: Obtain Capital Budget Requests
Validate all capital budget requests and forward them to the senior management team with comments and recommendations. Match to the fixed asset disposal report to ensure that assets are being replaced.
Step 11: Update the Budget Model
Input all budget information into the master budget model. Verify that payroll tax rates in the model are updated for the budget year. Update the depreciation expense in the model, based on the fixed asset disposal and capital budget request information already received.
Step 12: Review the Budget
Meet with the senior management team to review the budget. Highlight possible constraint issues, and any limitations caused by funding restrictions. Also test for the validity of the turnover ratios for accounts receivable, inventory, and accounts payable in relation to historical metrics, as well as sales per salesperson. Note all comments made by the management team, and forward this information back to the budget originators, with requests to modify their budgets.
Step 13: Process Budget Iterations
Track outstanding budget change requests, and update the budget model with new iterations as they arrive. Be sure to update estimated interest expense and interest income, as the financing portion of the budget is clarified.
Step 14: Obtain Approval
Forward the budget to the board of directors for approval. This needs to be timed to coincide with the next board of directors meeting, though the board chair may authorize a budget approval without requiring a formal board meeting. The controller should be available to discuss budget issues with any board members who have questions.
Step 15: Issue the Budget
Create a bound version of the budget and distribute it to all authorized recipients. This should include all members of the board of directors, all senior managers, and all department managers.
Step 16: Load the Budget
Load the budget information into the financial software, so that you can generate budget versus actual reports. Be sure to cross-check the inputs to guard against data entry errors.
Step 17: Verify the Loaded Budget
Compare the budget loaded into the accounting software to the approved budget version, and adjust for any errors.
Step 18: Lock Down the Budget
Initiate password protection of the budget model. Also, create a copy of the model and archive the copy.
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