This is from the “Accounting Makes Cents” podcast episode #52 released on Monday, 6 November 2023.
In today’s episode, we are going to talk about budgeting. Budgeting in a company is a strategic endeavor that involves meticulous planning and allocation of financial resources. It serves as the cornerstone for decision-making, resource management, and ultimately, the success of the company.
Effective budgeting is paramount. It’s about setting clear financial targets, aligning resources, and ensuring the company is on a path towards sustainable growth.
Jump to show notes.
So let’s start with the purpose of budgeting.
Budgeting in a large company provides a structured framework for achieving financial goals and objectives. It’s akin to a blueprint that guides departments and teams towards shared targets, ensuring resources are allocated efficiently and effectively to achieve these goals.
Encouraging departments to take ownership of their budgets fosters a sense of accountability and responsibility. It empowers teams to make informed financial decisions that contribute to the overall success of the company. However, it is important to acknowledge that employees may sometimes be reluctant to participate in the budgeting process. This reluctance can stem from various reasons, such as a lack of understanding about the budgeting process, fear of budget constraints impacting their projects, or feeling disconnected from the broader financial goals of the company.
So what is entailed in the budgeting process?
The budgeting process begins with top-level executives setting the strategic direction and financial objectives for the company. Excellent communication is important during this process because it’s crucial for leaders to articulate the company’s vision and ensure it’s understood and embraced throughout the company. Addressing employees’ concerns and providing clear context for how their contributions fit into the larger financial picture can help overcome reluctance and encourage active participation.
Subsequently, departments translate these objectives into tangible budgets. Each department meticulously plans their expenditures, accounting for factors such as salaries, operating costs, and capital investments.
This collaborative effort ensures that resources are allocated where they are needed the most. It’s about aligning the financial plan with the specific needs and priorities of each department.
These individual department budgets are then consolidated into a master budget, offering a comprehensive view of the company’s financial landscape. The master budget serves as a unifying document, harmonising the financial plans of various departments into a cohesive strategy for the entire company.
So what do we use budgets for?
Two of the biggest uses of budgets are for variance analysis and performance metrics. Once the budget is set, it’s imperative to monitor performance against the plan. Variance analysis is a critical tool used to compare actual results with the budgeted figures.
Variance analysis isn’t about assigning blame; it’s about learning and adapting. It provides valuable insights into the performance of each department, finding out what went wrong, finding out what went right, enabling them to make informed adjustments as needed.
Performance metrics like return on investment (ROI), sales growth, and cost-to-income ratios are closely monitored to ensure the company is on track to meet its financial goals. These metrics serve as indicators of progress towards the company’s financial goals. They guide decision-making and help maintain focus on the strategic priorities.
Are there different budget techniques?
Of course! Now, let’s explore different budget techniques that companies may employ to manage their finances effectively. There are several techniques companies use, tailored to their specific needs and industry. Here are a few notable ones:
Incremental Budgeting: This approach involves using the previous period’s budget as a baseline and making incremental adjustments based on expected changes in the upcoming period. It’s a straightforward method but may not account for significant shifts in business conditions.
Zero-Based Budgeting: In this technique, every budgeting cycle starts from scratch, requiring departments to justify all expenses, regardless of prior budgets. It forces a thorough evaluation of all costs and can lead to more efficient resource allocation.
Activity-Based Budgeting: This technique links budgets to specific activities or tasks, providing a detailed view of resource allocation based on the activities that drive value for the company. It’s particularly useful in industries where costs are directly tied to activities.
Rolling Budgets: Unlike traditional static budgets, rolling budgets continuously update based on a fixed time frame, often extending 12 months into the future. This allows companies to adapt more quickly to changing market conditions.
Beyond Budgeting: This approach challenges the traditional budgeting process by emphasising a more flexible, decentralised approach to financial planning. It focuses on providing managers with the necessary information and autonomy to make informed decisions in real-time.
Remember that each of these techniques has its own strengths and weaknesses, is suited to different business environments. Companies often choose the one that aligns best with their strategic goals and industry dynamics.
What about limitations to budgeting?
While budgeting is a powerful tool, it’s important to acknowledge its limitations. One significant challenge is the potential for rigidity. In rapidly changing markets, It’s important to recognise that while budgeting is a valuable tool, it may face limitations. For instance, in rapidly evolving markets, strict adherence to a budget may hinder the company’s ability to seize new opportunities.
Additionally, budgeting may sometimes lead to short-term thinking. Departments may focus on immediate goals at the expense of long-term strategic initiatives, potentially limiting the company’s overall growth potential.
Lastly, budgeting relies on historical data and assumptions about the future. Unexpected events or unforeseen market shifts can disrupt even the most carefully crafted budget, highlighting the need for adaptability.
These limitations underscore the importance of budgeting. We need to combine budgeting with strategic flexibility and a forward-looking mindset. It’s about striking that balance between planning for the future and adapting to the present reality.
Show notes simplified
In this episode, MJ the tutor explores all things budgeting – from the process of putting together budgets, including employee feelings around the whole thing – to the different types of budget techniques – to the limitations of budgeting.
Credits:
“Ding Ding Small Bell” (https://freesound.org/s/173932/) by JohnsonBrandEditing (https://www.youtube.com/channel/UC1RImxnsbfngagfXd_GWCDQ) licensed under CC0 Licence.
MJ THE TUTOR 