How to Determine the Most Effective Budgeting Process

A budget is a systematic method of allocating financial, physical and human resources to achieve strategic goals. Companies develop budgets in order to monitor progress toward their goals, help control spending, and predict cash flow and profit.

The most effective budgets are those that:

• Communicate and support strategic goals.
• Identify risks in relation to the company's long-term strategy.
• Provide information to help management make better decisions.
• Facilitate goal setting and measurement.
• Deliver consistent realistic figures companywide.
• Accommodate changing business conditions.

The goal of companies that apply best practices is to develop budgets that give managers a well-designed tool to manage effectively. To do this, companies use technology effectively; just as important, they develop procedures that work in their industry and with the culture of their company.

The central challenge to budget developers is that by trying to map the future for a company, they are attempting something that can never be done with perfect precision. With a greater number of companies competing in multiple, global markets, and with economic and technological change accelerating, companies need to develop budgets that strive for precision but also can accommodate business conditions that will certainly change.

Important benefits of improving the budgeting process include:

• Better companywide understanding of strategic goals
• Better support of initiatives supporting those goals
• The ability to respond more quickly and forcefully to competition
• Cost savings, through better practices in every unit that does budgeting

Applying performance measures to the budgeting process is also key to process improvement. Performance measures are the "vital signs" of an organization. Quantitative measures of performance provide management with insight into company performance and highlight opportunities for improvement. Such measures provide a company with the information needed to benchmark with another company, compare performance with industry standards and averages, and track any progress in performance improvement over time. By using performance measures, managers and workers understand the outcome of their efforts and how those efforts affect the rest of the organization.

To be meaningful, performance measures must be quantified: an act of measurement is required, one that can be performed reliably and consistently with a basis in fact, not opinion. "Good" and "fast" are not adequate performance measures. "Number of defects" and "time for order processing" are acceptable measures, if they are controllable — that is, if the people performing the work can affect the outcome. In addition to being quantifiable and controllable, to be truly effective, performance measures must also be:

• Aligned with company objectives
• Supportive of continuous improvement
• Reported consistently and promptly

Performance measures can be cost-based, quality-based or time-based. Cost-based measures cover the financial side of performance. Quality-based measures assess how well an organization's products or services meet customer needs. Time-based measures focus on how quickly the organization can respond to outside influences, from customer orders to changes in competition. Focusing attention simultaneously on cost, quality and time can optimize performance for an entire process and ultimately an entire organization.

A few cost-focused performance measures for the budgeting process include:

• The total cost of financial budgeting and planning as a percentage of revenue.
  • A higher-than-average ratio may be due to higher compensation to staff involved when preparing and analyzing the budget or to excess staffing in the budget process. Other reasons for a higher ratio include a process that is highly decentralized or one that uses technology that needs updating. Some companies, however, will have a higher ratio because their revenue is below the benchmark group average. A lower-than-average ratio may be due to lower compensation rates for budget preparation staff or a staff that is less highly skilled. However, a company that uses technology efficiently will also have a lower-than-average ratio, as well as a company with revenue above the benchmark group average.

• The number of full-time equivalent (FTE) staff, as a percentage of total staff, devoted to budgeting.
  • FTE is defined as equal to 40 hours.

• The number of budgets produced annually.
  • A higher number of budgets indicates that more time and resources are being spent on budgeting.
  • Some reasons that a company might have a higher-than-average number of budgets:
    • Preparing different types of budgets for the same financial entity
    • Creating budgets that include too much detail
    • Requiring many revisions of budgets
  • By contrast, a company might have a lower-than-average number of budgets due to the following factors: synchronizing budgets for each entity, simplifying required details, and providing clear guidelines on strategies and assumptions so that less revision is required.

Learn more about the budgeting process through the following tools on KnowledgeLeader: