Few things in the business world inspire as much stress and frustration as preparing annual budgets. Business unit managers dislike how the time-consuming process disrupts their daily workload and affects bonus calculations; executives worry about establishing differing figures across departments; and finance leaders grow tired of a process that often doesn’t lead to better spending decisions. It comes as no surprise that PwC released a white paper suggesting that annual budgets are “little more than paperweights” and that “many budgets become obsolete before the fiscal year begins.”
However, despite these concerns, organizations still need budgets to hold business units accountable for expenditures, reducing costs, making effective decisions, and preparing for worst-case scenarios. This raises the question: How can you best prepare for budget season?The answer is not to eliminate the process, but to use the following budgeting best practices to transform the process into a strategic business initiative.
1. Support Projections with Facts
Before the actual budgeting discussions begin, business unit managers should be required to perform an analysis to support all key assumptions and projections with facts. Writing for Harvard Business Review, Jason Green of The Cambridge Group recommends that each business unit builds a case “starting from demand and working back to internal cost, capacity and capability measures.” If demand for a product is expected to increase, ask: Why will your company benefit from this growth in demand to win new customers rather than the competition? Once demand is established, you can have detailed discussions about the costs necessary to meet that demand.
Green recommends making it clear that projections “need to be supported by facts, and that any key assumptions behind projections must be detailed.” Starting with fact-based demand ensures that the budgeting process includes realistic projections for growth and profitability.
2. Align Resources with Strategic Goals
Budgeting is not just a financial exercise. The most important aspect of budgeting is to ensure that a company’s financial resources are being used to further its goals and priorities. Every business unit is in competition for the company’s finite resources. In some cases, organizations spread resources evenly across all business units, or budget based on last year’s numbers plus inflation.
For better budgeting results, however, organizations should allocate resources strategically. This means budgets should fully fund the business units that are the top drivers of profit and growth and the departments that align with the company’s highest priority business goals—before moving down the list. Business units at the bottom of the list will then receive whatever budget remains at the end of the process.
While this approach will face understandable push-back from business units on the bottom tier, when budgets are linked to a transparent strategy that’s clear to all involved, managers and employees will have a better understanding of the company’s goals. This can be reinforced through regular reviews with business unit managers that track financial and strategic goals. “This understanding,” explains Inc., “in turn, leads to greater support for goals, better coordination of tactics, and, ultimately, to stronger company-wide performance.”
3. Allow Room for Change
Flexible budgets free business unit managers from padding their budgets “just in case.” This leads to leaner, more realistic budgets. You can build in flexibility by setting aside funds at the business-unit level and updating the budget as frequently as needed to reflect external variables. A flexible budget will serve your organization better than one that ignores the reality of running a business.
Neubrain, a provider of business analytics and performance management solutions, writes, “Static budgets and multi-year financial plans produce high level financial targets and constraints, but not the roadmap to success.” Developing a budget that accommodates change allows organizations to respond to threats and shifting market conditions more quickly and with greater precision. When opportunities arise, companies can then use resources to make advantageous decisions; no business unit should have to wait until next year for more resources.
4. Strike the Right Balance of Detail
More detail in a budget breakdown does not necessarily mean better decisions: Too little or too much detail can impact the budget process negatively. For example, extensive details often require a more time-consuming process and iterations; the cost of the budgeting process outweighs its benefits. On the other hand, too little detail, especially while budgeting for volatile revenue, may lead to miscalculations.
In Deloitte’s guide, “Babies, Bathwater, and Best Practices: Rethinking Planning, Budgeting, and Forecasting,” the following recommended questions are posed:
Where are we headed? Easy access to a few key details can help you predict shifts in the company’s overall financial trajectory. Identify and track the three to five factors—internal and external—that have the biggest impact on the business. A consumer products company may keep a close eye on sales volume, marketing spend, and the cost of key materials.
How will we get there? To direct the business, you need access to the right level of detail to know how money is being spent and the value it’s generating—perhaps even down to the individual customer or product and service level.
5. Implement AP Automation
Introducing technology to the budget process can vastly improve the budgeting and performance management capabilities of an organization. Consider accounts payable (AP), a process that is immensely important to an organization because it involves verifying, paying, and accounting for nearly all of a company’s outgoing payments outside of payroll. An automated AP solution makes data more accessible, highlights trends and exceptions, and offers insights based on statistical and quantitative analysis and predictive modeling.
Most companies run their operations on a quarterly basis, even though they prepare budgets annually. As a result, the annual budget is out-of-date and irrelevant almost as soon as it is released. An automated solution allows budgets to exist in real-time and helps streamline and speed up a process that could otherwise take months. As Ariett’s “Guide to Best Practices for Modern Accounts Payable” suggests, “AP automation opens up a golden opportunity for accounting to utilize reporting and business analytics based on specific metrics and dimensions. With the right reporting tools, the accounting team can deliver insight to the executive team regarding spending, vendor contracts, operational bottlenecks, and department budgets.”
An automated AP solution allows companies to manage their budgets without losing track of expenses and actual payments, showing the leadership team when important targets are being met and when others are falling short. This helps companies focus on the real goal of budgets: to make better financial decisions.
However, don’t assume that simply automating your budget will improve the process. Automating an ineffective budgeting process just speeds up bad practices. Instead, take steps to improve your budgets and the process you use to develop them and use automation to make good processes more efficient. It will provide better visibility and control of your organization’s financial management and planning.
The Bottom Line
Above all else, following these budgeting best practices can save your company time. By aligning your budget with a clear strategy while utilizing the right automated technology, you will keep your team organized and motivated. Properly developed, your budget can provide a solid foundation that allows your company to make stronger decisions and to take advantage of opportunities within an increasingly competitive marketplace.