Many companies rush into buying budgeting automation software without first documenting a set of budgeting best...
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practices. By examining current practices and comparing them to best practices, companies will be ready to deploy budgeting software most effectively.
One person must be responsible for the overall budget. That person, if not the CFO, should report directly to the CFO. A clear vision must be published, describing where the company is headed. The budget, then, is the development of short-term plans that deal with operational efficiency and strategic objectives. The vision may relate to managing costs and operational efficiency, building new strategies, making capital investments and planning for revenue growth.
Budgeting best practices: The five pillars
Let's look at budgeting best practices and points to consider when evaluating budgeting automation software.
- Impart operational efficiency. The first pillar of budgeting relates to departments that have mature product lines. For this area, there are no dramatic goals for revenue attainment. Value is achieved by maintaining or lowering operational costs. Operational efficiency has clear value to the bottom line.
- Plan for growth. The second pillar relates to areas that the leadership team has identified as targets for growth. As such, the budget must reflect the new revenue targets and the operational costs required to achieve these targets.
- Budget for projects. The completion of a project means that a corporate objective has been achieved (e.g., building a new factory). Projects consist of tasks that are interdependent and have costs associated with them that must be budgeted as the project moves toward completion.
- Account for capital expenditures. Capital expenditures require special accounting and special budgeting. For example, a capital expenditure may be required for a major software project. Although a project of $1 million may be completed in one year, the impact on the P&L may be only $200,000 a year. But the impact on cash is $1 million for the year.
- Consider the time frame for the implementation strategy. For a long-term strategy (say expanding to Eastern Europe), the budget reflects the first year of the strategic plan.
Group leadership, application integration also key
Budgeting best practices also include deciding how many individuals are responsible for creating budget inputs. Team members report to a group leader who reviews each budget and works with that person to edit the budget until it is finalized. The group leader also consolidates the budgets into a single format and forwards them to the leadership team.
To make all this work, management must publish a calendar at the beginning of the budget cycle indicating when budgets are due and the revision cycle that the team will follow.
In many cases, creating a budget also requires data from other packaged applications, such as ERP, accounting, human resources, manufacturing and logistics. In some cases, budgeting takes place in the feeder system, and then values are uploaded to the budgeting application. To make budgeting easier, a level of data transfer is often useful between other systems and the budgeting system.
Driver-based budgeting is another approach worth considering. Rather than input budget data directly, it is often useful to deploy "drivers." A driver is a variable that impacts budget items. For example, knowing the production level in manufacturing makes it easier to derive budget data for the cost of goods sold. Knowing the head count in a department makes it easier to estimate healthcare benefits. Budget data must still be derived, but it is much more accurate when drivers are used.
Many companies produce a 12-month budget but really run their business on the basis of the next three months. This is called a rolling forecast. In this approach, at the end of each three-month period, a new budget is created. From a methodology point of view, companies must decide if the rolling forecast approach is valuable, rather than running the company by using the traditional 12-month approach.
Because the purpose of creating budgets is to help run the company better, it is also important to create a budgeting book, which is a series of tabular reports and graphs for management. Even better would be to have software that allows managers to create their own what-if analyses and other simulations.
Finally, the ability to make midcourse corrections is another characteristic of effective budgeting. Because budgeting helps provide a level of management supervision, a company must decide how to report month by month, how to develop an early warning system and how to take corrective actions. If, for example, a department is 30% over budget after the first month, this could be a major problem.
Although many budgeting automation systems can be quite valuable, the value of these systems can be increased dramatically if you first document and then follow budgeting best practices.
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