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Table of Contents
01. Introduction
Budgeting is a critical discipline for any FP&A team to master. Given the rapidly changing economy, geopolitical turmoil, the increasing impact of technology, and competition, budgeting is a vital skill organizations need to excel in today’s environment.
Organizations approach budgeting in different ways. Some collect budget information at a low level of detail and then roll-it up to create a business plan. Others start with the business plan and use budgeting to operationalize the strategy and align the various sectors of the organization. Budgeting is mainly used for this operational alignment of expense and revenue targets. Still, it is also critical in other areas, such as capital planning, cash flow budgets, and position-based budgeting.
This report explores how to leverage the budget discipline to win in today’s business environment. To implement an effective budgeting practice that aligns with enterprise planning, organizations must implement a technological foundation to provide a framework to operationalize budgeting.
Effective budgeting will require agile cloud-based solutions that support changes due to forecast and plan shifts, can be managed by end-users with minimal IT dependency, and are flexible and easy to use.
02. Why the budget is actually your best friend
Given the complexities of a global economy where new financial challenges occur seemingly every day, budgeting is a central tool for building resiliency into your business.There are four key reasons for this - let’s examine them now.
It builds alignment to enterprise goals and plans
Budgeting connects the enterprise business plan to individual business units and helps them direct activities to meet those business plan objectives. Budgeting at a detailed level of expense and revenue becomes the “roadmap”, supporting an organization’s plan to allocate and manage resources appropriately.
It ensures financial consistency
Budgeting encourages individual organizations to align spending with revenue projections and assumptions - to support financial goals and provide financial consistency.
Preparation for the unplanned/unexpected
Done correctly (in a flexible manner) budgeting enables individual organizations to address unforeseen impacts, make changes that reallocate funds, and set up contingencies where needed.
Provides a benchmark against which to measure performance
Budgeting provides individual organizations with financial awareness of their performance and how they contribute to the enterprise's goals. It helps them make critical decisions on spending and prioritization within an enterprise context.
03. Budget types and techniques
Aligning financial budgeting with operational budgeting (i.e., for sales performance management, production, headcount, marketing, etc.) is critical as budgets are decentralized and cascaded within the company’s organizational structure, processes vary based on the size of an organization, specific requirements of the business, support of economic partners, and industry/vertical requirements.
Main types of budget deployed in organizations today:
Operational budget
The most common type of budget used by organizations. It combines revenue and expense responsibilities for an organization for a specific period, such as monthly, quarterly, or annual. On the expense side, it often includes budgets for administrative expenses, sales, marketing, production, research and development, and personnel expenses.
Master budget
The master budget is the sum of all budgets supporting the enterprise business plan. Firms should be able to aggregate the individual organization budgets to many intermediate points, such as district, division, VP-level, business unit, country/region, product, and enterprise.
Capital budget
Focuses on an organization's long-term investments in real estate, property, equipment/machinery, transportation assets, and technology.
Cash flow budget
Forecasts cash inflows and outflows during a specific period, usually monthly. Due to variability in customer payments and economic changes, flexibility must be maintained to change courses quickly if needed.
Budget techniques
Multiple budgeting techniques have emerged that an organization can deploy to improve budgeting. They are not mutually exclusive - organizations may deploy several methods that will act in a complementary manner.
Flexible budgeting
Unlike a static budget, this enables changes in activity levels and sales targets. It allows for adjusting specific budget amounts for budget categories (i.e., accounts, product categories) due to fluctuating sales, demand, or changing market impacts. This contrasts with a static plan in the official annual communication externally to shareholders.
Zero-based budgeting (ZBB)
This approach requires departments to justify all expenses as if they were new businesses in each budgeting cycle. Each budget item must be justified regardless of whether it was included in previous budgets. Proponents of this approach believe it encourages cost-consciousness and efficiency. Budget assumptions are challenged each budgeting cycle, and resources are reallocated based on current priorities.
Activity-based budgeting (ABB)
This approach links budgeting to the organization that drives costs by allocating resources based on each activity’s anticipated/standard cost. Proponents believe ABB provides a more accurate representation of the cost structure supporting enterprise operations. It is a component of the activity-based management (ABM) discipline.
Incremental budgeting
Enables agility through making smaller, focused budget adjustments due to changes in business conditions. Proponents of this approach believe it is less time consuming than other methods, and is appropriate for organizations that see less change. In contrast, critics believe it will perpetuate bad habits and inefficiencies inherent in prior budgets and could cause an organization to miss new opportunities.
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