What Is Budget Preparation?

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For a business, a budget is a resource management tool used to determine a course of action that will make the company more efficient and more profitable. In many organizations, budgeting is also called planning. Budgets are usually prepared once a year, but as the year progresses if actual results start to vary significantly from what was budgeted, top management may ask department managers to revise their budgets for the rest of the year in light of these factors.

Responsibility and Philosophy

  • Many times, the finance department is put in charge of the budgeting function because these staff members are proficient with building financial models and preparing budget templates using spreadsheet software. Companies have differing philosophies regarding budgeting. Some prefer a top-down approach in which senior executives decide on the major goals for the upcoming year. Others take a more organic, bottom-up approach in which individual departments are given considerable latitude in determining the assumptions they use for their budgets.

Goal Setting

  • Goals set for the company should be attainable but require maximum effort and creativity out of each department and each employee. Revenue targets must be realistic enough that mangers responsible for generating revenues can translate them into unit sales projections that are possible to achieve -- not just hopes or wishes. Companies must set both short-range goals for the upcoming year and longer-term goals. This expands managers' thinking beyond day-to-day duties and deadlines. Companies that don't set and work toward long-range goals may find themselves falling behind more visionary competitors.

Strategy Development

  • Strategies are the actions that a company takes to secure customers for its products and services. But these are more than a to-do list of tasks. They must be based upon a clear understanding of the company's strengths and its competitors' vulnerabilities. The company seeks to choose marketing strategies that will get an immediate positive response from its target customers by motivating them to make a purchasing decision. They must also reflect the reality of the financial and human resources the company has available to implement the strategies.

Resource Needs

  • Each step that goes into implementing a strategy will require the expenditure of money or employee time. Department managers determine the projected costs for the functional areas they are responsible for. It is critical that these projections are based on real-world information, not guesses about what things will cost. Is also critical that each task is broken down into components so precise cost estimates can be made. If all applicable costs are not determined, actual results will show negative variances, and the budget process will not have achieved its purpose of accurately projecting the company's future performance.

Create Department Plans and Consolidate

  • Once the process of forecasting revenue and expenses is completed within each department, the resulting department budgets are sent to the finance department to compile into the budget for the entire organization.

Review, Negotiate and Finalize

  • Top management reviews the full budget and decides, usually with the analytical assistance of the finance division, whether any changes need to be made. Marketing managers may be too optimistic about sales for the upcoming year, for example, and senior management may ask them to trim their projections. Very often, expenditure cuts are recommended. Finalizing the budget may require negotiation between senior management and department managers who want to present the reasons why their budget should not be cut.

References

  • "Financial Management 101: Get a Grip on Your Business Numbers"; Angie Mohr; 2007
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