Budgeting Process

What is a Budgeting Process?

A budget is a tool for planning, implementing, and controlling activities for optimum utilization of scarce resources in a business. It explains the company’s objectives and the course of action it will choose to achieve its goals in detail. Also, it mentions the controls to be put in place for achieving its successful implementation. The budgeting process is the process of putting a budget in place. This process involves planning and forecasting, implementing, monitoring and controlling, and finally evaluating the performance of the budget.

Budgeting is the process of planning future business activities by establishing performance goals and putting them into a formal plan. In other words, budgeting is the process of making financial goals for a company and creating a plan to achieve those goals.

What Does Budgeting Process Mean?

Creating a budget is much more than management sitting down and coming up with performance numbers that they want to meet in the next quarter. A budget is really plan for the company’s future. Managers and board members meet and discuss where they want to see the company in years to come, what markets they want to exploit, and what products they want to create. In order to achieve any of these long-term plans, the company must have a way to create opportunities and track the progress along the way. That is exactly what a budget does.

Goals of the Budgeting Process

Budgeting is a critical process for any business in several ways.

1. Aids in the planning of actual operations

The process gets managers to consider how conditions may change and what steps they need to take, while also allowing managers to understand how to address problems when they arise.

2. Coordinates the activities of the organization

Budgeting encourages managers to build relationships with the other parts of the operation and understand how the various departments and teams interact with each other and how they all support the overall organization.

3. Communicating plans to various managers

Communicating plans to managers is an important social aspect of the process, which ensures that everyone gets a clear understanding of how they support the organization. It encourages communication of individual goals, plans, and initiatives, which all roll up together to support the growth of the business. It also ensures appropriate individuals are made accountable for implementing the budget.

4. Motivates managers to strive to achieve the budget goals

Budgeting gets managers to focus on participation in the budget process. It provides a challenge or target for individuals and managers by linking their compensation and performance relative to the budget.

5. Control activities

Managers can compare actual spending with the budget to control financial activities.

6. Evaluate the performance of managers

Budgeting provides a means of informing managers of how well they are performing in meeting targets they have set.

What are the Approaches to the Budgeting Process?

There are two main approaches to the budgeting process. These are:

Top-down Approach

This budgeting process involves preparing the budget by the company’s senior management based on the company’s objectives. The departmental managers are assigned the responsibility for its successful implementation. Every department can opt to create its own budget based on the company’s broader budget allocation and goals.

This approach’s advantage is that the lower management saves a lot of time and gets a readymade budget to be followed. They hardly participate in the preparation of the central budget. The senior managers’ experience, coupled with past-performance figures, comes in handy in such budgeting processes.

Bottom-up Approach

This budgeting process starts at the departmental level and moves up to higher levels. Every department within the company is required to prepare plans for its proposed activities for the next budget period and estimate the costs it will incur. These individual budgets are combined to create a bigger all-inclusive budget.

The budgeting process with this approach can be lengthy and time-consuming. However, employees and managers are more motivated to achieve the budget goals since they have prepared it. They have the complete knowledge of what the budget actually expects them to do and how to achieve that. Such budgets tend to be more accurate and closer to the actual situation on the ground.

How to Develop a Good Budgeting Process

Knowing how a budgeting process works can help a company move in the right direction when thinking about its financial future. Review this step-by-step guide of the budgeting process:

  1. Identify assumptions and available funding.
  2. Highlight cost points and a budget package.
  3. Gather revenue forecasts and department budgets.
  4. Validate compensation and bonus packages.
  5. Amend the budget model.

1. Identify assumptions and available funding

Accounting department employees make assumptions on their budget to aid them with understanding trends associated with sales costs and environmental conditions. They need information about which trends may affect budgeting and funding efforts. They might know which areas to make changes to after they analyze this data and note the viability of projects with the funding they have. They should conduct market research to obtain data that they can apply to their analysis of the budget.

2. Highlight cost points and a budget package

Find out the organization’s cost points to include the change of costs into the budget package. Identifying the cost points assists the management team with figuring out factors that can alter a product’s cost. Use an outline from a previous budget to build the package that shows what the next year’s budget looks like. The budget package outlines the expectations the accounting department has for the budget before forecasting for the upcoming year.

3. Gather revenue forecasts and department budgets

Make sure the accounting department performs a revenue forecast to see the number of sales expected for the year. Understanding the number of sales permits the company to track the demand for products and services. Once the accounting department compiles the revenue forecast, they must coordinate with the senior leadership team to compile each department’s budget. They can then compare the data and dictate the work they need to complete to get a workable budget.

4. Validate compensation and bonus packages

Companies should factor in an employee’s compensation and benefits packages to increase employee morale. Increased morale motivates employees to give maximum effort in their roles and can magnify their performance. Collaborate with the human resources and accounting departments to retrieve this information before presenting the total company’s budget to management.

Each department must get approval from management on how they’ll compensate employees before they add the cost to the budget and communicate changes to these packages to employees.

5. Amend the budget model

Make final adjustments to the budget before sending it off to management for approval. Proofread the budget to catch errors that can extend or alter the decision making in the approval process. Go over the budget with the human resources department to see if it aligns with the execution of the company’s goals.