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Business budgets are the financial plan of the business. They are normally created for one year at a time and allocate the spending and revenue across business units, departments and accounts.
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Quick reference
Business Budgeting
Business budgets are the financial plan of the business. They are normally created for one year at a time and allocate the spending and revenue across business units, departments and accounts.
When to Use Business Budgeting
Most businesses create a budget annually. If a significant event occurs during the year that changes some of the basic assumptions upon which the budget was built, a revised budget will be created. Examples would be a merger or acquisition, a national or international crisis event that changes market conditions, or a business reorganization.
Instructions
- A business budget is a financial plan used to estimate the results of future operations.
- Plan – Intention of what to do or how to react to a problem.
- Estimate – a guess, hopefully an informed and educated guess.
- Future Operations – unknown conditions, based upon assumptions and desires. It includes all business functions such as sales, development, production, maintenance and general administration.
- It provides guidance to operating managers, and sets limits of spending authority; but it does not provide strict control on day-to-day decisions.
- Mangers will normally strive to meet the sales and spending targets set in the budget; but the actual business sales and spending seldom exactly matches the budget.
- There are many ways in which budgets can be set. These vary based upon the personalities of managers, business systems and processes in place, and experience of those involved. Some methods are quick, some are slow. They generally follow one, or a combination, of these approaches:
- Golden rule – the senior manager or owner decides what money to spend where.
- SWGO (Squeaky Wheel Gets the Oil) – whichever department or individual lobbies the best for money gets what they want, the rest is split among the others.
- SWAG (Stupid, wild, awful guess) – those making the budget don’t know what it should be so they just assign an amount in order to allocate something.
- ETOB (Every Tub on its Own Bottom) – each budgeted amount must full stand alone; it can’t not rely on any other business process or operation.
- ZBB (Zero-Based Budgeting) – every department starts with a budget of zero. They must provide justification for the amounts that are allocated in any of their accounts. No justification – no money.
- FMLA (Formula) – a formula or simulation is used that estimates sales and spending based upon a set of business assumptions.
- Extrapolation – the budget is based upon what has been budgeted or spent in previous years with appropriate business trends factored in.
- Spent – an organization gets the same out of money next year as they actually spent this year.
- TD (Top Down) – senior management uses the strategy to estimate sales and allocate spending in a manner consistent with strategic goals.
- BU (Bottom Up) – individuals and line managers estimate what they believe will be required to implement the elements of the strategy for which they are responsible.
- TD – BU – TD (Top down, button up, top down) – senior management does a top down draft budget, individuals and line managers do a bottom up draft budget, the two are reconciled, strategies are updated and targets revised. Senior management then issues the budget. This cycle can be repeated several times.
- The result of the budgeting process is the annual business budget, normally known as the Operating Plan or Op Plan.
- Ideally the Op Plan is the management intent of how to sustain the business and implement the strategy.
- It is often expressed as projected quarterly and annual financial statements such as Earnings Statements, Balance Sheets, and Cash Flow Statements. In publically traded companies, these will often be shared investors.
- This business level plan is used by the department managers to create detailed sales and spending plans for their department that are allocated into sub-accounts and spread across the 12 months of the year.
- The Op Plan is the financial target used to measure management’s performance during the year.
Hints and Tips
- Any of the budgeting can be used. I prefer TD – BU – TD in order to get both maximum insight and buy-in; but it takes time and effort.
- Don’t tell an organization that you will be doing a bottom up budget (meaning their input maters) if you aren’t really going to use that approach. The organization will feel that they have been cheated and lied to. If using one of the other approaches, acknowledge it. The organization will at least appreciate the honesty.
- It is OK to change Op Plans in the middle of the year if something unusual happens. A business I was working with in 2001 had four Op Plans during the course of the year. The original, a second one when an acquisition occurred, a third one for a reorganization, and the fourth one following the bombing of the World Trade Center in New York City.
- Don’t change Op Plans in the middle of the year just because you missed a target. You will be rightly accused of manipulating financial data to avoid responsibility.
- Take time to spread the money in the accounts in the pattern you think the money will be spent – don’t just spread it evenly across the 12 months unless you think that is what will happen. Otherwise, you will find yourself constantly explaining variances with the excuse of being late or early on spending. Soon the senior management in the organization will come to the conclusion that either you can’t plan or you can’t control your organization. A few minutes to spent spreading the sales and spending appropriately across the year will save time and improve your credibility.
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