The subject of budgeting is nothing new, and companies use some elements of this system for the purposes of planning, monitoring and analysis of their activities. Nevertheless, there are not many people who use this tool to its full capacity.
In this article we shall explore what a budgeting system is and why this does not work for some companies or at least not work at full strength.
The budgeting system, first of all, entails planning one’s activities, as presented in the form of a general budget for the company’s estimated income and expenditures, and a comparison of planned and actual values, the analysis of which reveals deviations and opportunities to make decisions for their elimination. The budgeting system allows entities to perform an advance assessment of the future results of management decisions that are being made today.
Budgets for a specific period are based on the tasks before the company as a whole, as well as for each separate division thereof. To this end, management creates a system of key performance indicators (KPI) and annually reviews and approves them, while simultaneously developing the development strategy for the following year. By properly constructing a system of key performance indicators, management clearly understand the objectives of each division, as well as its employees, in order to achieve profit, while employees are also interested in obtaining good results on a par with the company.
In practice, however, we encounter that the KPI system may be rather formal in its approach, since these indicators are abstractly invented. If planning happens by itself, in isolation from real activity, it is often the case that the choice of indicators and their target values are not conducive to achieving the main objectives. Thus, it is arbitrarily performed and not always justified.
Another indicator – the fact that the budgeting system is formal – results in the lack of monitoring and comparative analysis regarding the implementation of budgets and the failure to identify actual deviations from the plan. This situation can occur when management believes that budgeting is a waste of time, does not adhere to the strategic plan, makes spontaneous decisions, and also does not require any analysis of the current situation with the company.
With the introduction of a budgeting system, the company may choose one of the following budgeting methods: “top-down” planning, “bottom-up” planning, and “objectives down – plan up” planning.
In the first case, the company’s management independently establishes objectives and develops sales plans.
In the second case, the sales department develops its own objectives and plans, which are sent to management for approval.
In the third case, management develops objectives and strategic development indicators. Based on objectives, the sales department creates a plan and a budget for the resources required in order to implement it. Plans and resources are reviewed and approved by management.
The best performance is achieved specifically in the third case of planning, when there is interaction between management and employees. In applying the first method, when the company’s management lowers objectives for a plan where they were inflated, employees often begin to work in a slipshod manner and look for arguments as to why they can not fulfill the plan, rather than looking for ways to implement it. By using the second method, when planning takes place at the level of sales managers, this may lead to an underestimation of the plan in order to increase their income.
The finance department formats and determines the budgets and, depending on the asset being managed, divides this into functional, operating and auxiliary budgets.
The functional budget is a budget that describes a specific aspect of the division’s activity, where the budgets include a budget of revenues and expenditures, and a cash flow budget.
The operating budget is a budget that is allocated for the division’s business transactions.
The support budget is a budget, prepared at the initiative of the division for the purpose of confirming specific numbers (results) in their operating budgets.
After management takes decisions regarding budgeting, chooses the budget’s format and the methods for it’s preparation, it is necessary to answer the following question: how should this practically be done? Many companies try to save money and develop a budgeting system in Excel and, while this may work successfully as long as the company remains small and works with small budgets. With the development of activities, and the opening of branches and representative offices in the regions, Excel will no longer be a sufficient solution. It becomes difficult to develop several different budget options and to handle fiscal consolidation. In addition, information is not protected from changes and also does not contain a history of past edits. But the main drawback of this program is the inability to work collectively in such a program.
In this case, management ends up deciding to introduce an automated system solution for full budget management. There are about a dozen noteworthy proposals on the market, whereby automation fulfills the main objectives of each company:
- Forming budgets for subdivisions, a budget with revenues and expenditures, and a cash flow budget;
- Monitoring the implementation of budgets on the basis of actual evidence;
- Adjustment of budget target indicators in accordance with the current situation.
Developing a budgeting system is a complex process and, thus far, nobody has managed to develop a perfect system. Therefore, it is unlikely possible to eliminate the deviation of actual indicators from those that are planned. If a company plans to take this step or if they already have had a bad experience when it comes to implementation, EBS consultants will help you minimize such roughness.
Author: Svitlana Korobko