Budgeting Process

Budgeting Process

Budgets are often met with much hesitation. Often times, managers feel that the process is often too long and really does not help them run their departments or business. LetÐŽ¦s explore the various stages of the budgeting process and evaluate their effectiveness. Then review how the role of the budget could serve as an analytic tool and be used to evaluate organizational performance, eliminate inefficiencies in an organization's performance, and be a part of the business control cycle. How can a company go from point A to point B? According to Leading Edge Alliance, a budget is like a roadmap for business growth or driving directions (2007). What does budgeting entail?

The Process

Budgeting is the process of: identifying, gathering, summarizing and communicating, financial and non-financial information about the companyÐŽ¦s activities for a set period.

During the identifying phase, activities consistent with corporate strategy are identified by various departments such as: production, marketing & research and management. Once identified, activities are evaluated and screened by estimating how they affect future firm cash flows and hence, the firm's value (Peterson & Fabozzi, 2002). This stage is important to the company's future success. It provides management with the opportunity to carefully match the goals of the company with the resources necessary to reach or exceed those goals. Gathering information may start with an estimate of expected revenues and costs, but as the analysis is refined, data from marketing, purchasing, engineering, accounting, and finance functions are put together (Peterson & Fabozzi, 2002).

In creating a budget, decision makers attempt to forecast numbers as accurately as possible. Doing this requires detailed assumptions regarding future costs and returns on investment. While historical data can provide insight into future performance, it is by no means a reliable method that should be expected to provide consistent results. Essentially, historical data is a "best guess." The level and validity of the assumptions are open to interpretation. As noted in the passages below, assumptions are required to create budgets for a company, department, or given project.

The first step in the budgeting process is to develop and communicate a set of broad assumptions about the economy, the industry, and the organization's strategy for the budget period. This is frequently done by planners and economists and is approved by top management. These assumptions represent the foundation on which the action plans for the budget period are built.

A number of assumptions about the timing of cash receipts and disbursements must be made when the cash budget is prepared. Once the assumptions about the timing of cash receipts and disbursements have been made, the preparation of the cash budget is a straightforward mechanical process.

The cash budget, with its assumptions about collections of accounts receivable and payments of accounts payable and other liabilities, purchases of equipment, and payment of dividends and other financing activities, is the source of many budgeted balance sheet amounts.

The most challenging parts of the budgeting process are developing the sales forecast, coming up with the assumptions related to the timing of cash receipts and disbursements, and establishing policies for ending inventory quantities, the minimum desired cash balance, and other targets (Marshall, et. al, 2004).

Assumptions are necessary to create a capital budget and are based on previous empirical data with the hope of predicting future events (growth, expenditures, sales, profit, earnings etc.). The more detailed the assumptions, the more likely they are to provide an accurate portrayal of future events. For example, retailers have supporting data that they will do 80 percent of their business between Thanksgiving and Christmas, thus they can assume for planning and budgeting purposes this number will remain consistent. However, it is always prudent to look at external factors which may impact historical data. For example, if the economy is in recession and revenues are largely reliant on consumer spending, it may be helpful to investigate how previous recessions have affected similar businesses in the industry. Again, more information can help provide a clearer picture of future results.

Summarizing is the part of the budgeting process that entails relating the short-term activities to the companyÐŽ¦s long-term goals and establishing performance measures in relationship to budget activity. Finally, communication during the entire process is critical to the company. Budget information must be communicated to the individuals who are accountable for a particular department. Remember it is the directions that will allow them to take their department from point A to point B. Management can set expectations and coordinate the activities. It is at this point, that management can challenge and motivate their staff with the establishment of performance measures that have rewards tied to them (Cingoranelli, 2006).

Analytical Tool

Budgets can also be used as an analytic tool to evaluate organizational performance. ÐŽ§Budgets are useful because the preparation of a budget forces management to plan. In addition, the budget provides a benchmark against which to compare actual performanceЎЁ (Marshall, et. al, 2004).

Managers are responsible for carrying out plans. They are expected to undertake specific tasks, make the necessary decisions and manage staff. Budgets help to assess levels of success in carrying out these responsibilities. They do not cover the full range of managers' responsibilities but are certainly useful in assessing performance in relation to responsibilities involving money. However, managers should not rely on financial results in isolation. They also have non-financial responsibilities that cannot be ignored. Managers need feedback on all the activities they undertake to build up full pictures of how effective they are. A true performance based budget is not simply a budget with some program goals attached. It says that for a given level