Budgeting in a company: a system of financial planning and control of financial flows
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Business owners bear responsibility not only for business development but also for managing the financial standing of the company.
If management and accounting are not organized properly, financial management becomes more complicated and takes up a significant part of the owner's management time.
If you own a business and want to manage it effectively, we recommend that you introduce a budgeting system into your company.
Budgeting is one of the financial planning and control tools that allows you to:
- estimate the company's objectives in financial terms;
- rationally allocate the available financial resources to ensure the full functioning of the business;
- to forecast the desired amount of financial resources;
- set upper and lower limits for expenditure;
- establish control over the achievement of sales targets;
- analyze the planned and actual performance of the company.
Today, Pravova Dopomoga specialists will share their experience of implementing budgeting in companies operating in Ukraine.
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Pattern: business plan – financial model – budgeting – tax forecasting
You may wonder, "Why do I need a budget when I have already developed a financial model that provides for the desired profits?"
Indeed, before starting a business, the owner has developed:
- a business plan describing the company's objectives;
- a financial model – a financial expression of the company's objectives (ambitious planning of revenues and expenditures and desired profits).
In practice, effective money management is not limited to these two tools.
The main differences between the budget and the financial model include:
- The financial model is developed extensively and budgeting is elaborated in a detailed analytical manner (analytics in terms of expenditure and income items).
- Budgeting includes not only planning but also control methods.
The method of control plays a crucial role, making it possible to analyze the rationality and purposefulness of the company's spending and to compare the costs with the returns.
For example, the financier or owner, while analyzing the budget, realizes that a particular department (hereinafter CFR - center for financial responsibility) does not fulfill the planned sales indicators even by 50%, but the fulfillment of the expenditure plan reaches 90%. That is, this CFR suffers a 40% loss.
This is the red flag for the head of the CFR and the owner about the department deviating from the norm. In the absence of budgeting and plan execution control, the profit of one CFR may "overlap" the loss of the other and not come to the owner's attention. But if the owner wants to be sure that financial resources are used rationally, the head of the CFR should justify deviations of budget indicators.
Like most business management mechanisms and tools, the principles of budgeting were borrowed from abroad. Large Ukrainian businesses started implementing a budgeting system about 12 years ago. Today, small and medium-sized businesses implement budgeting more often from the first months of operation, as "accounting for accounting's sake" is increasingly being pushed out of everyday life, and owners wish to exercise control over the financial component of the business.
Despite the benefits of budgeting, many companies still ignore it. The main reasons include:
- owners' lack of understanding of the effectiveness of the budgeting mechanism;
- unwillingness to spend financial and human resources on developing a budgeting system. You indeed have to work hard to start budgeting, but this work is the basis for easy planning and control in the following years of the company's activity.
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Introducing budgeting in the company
Owners, top management, and heads of departments are involved in the development and implementation of the budgeting system.
The basis for budgeting is the strategy and financial model, which is detailed into divisional budgets. The latter, in turn, consist of income and expenditure items.
The implementation of budgeting consists of several stages:
1. Development of a Budgeting Regulation.
Note. The Budgeting Regulation shall specify: terms, basic principles of budgeting, budgeting methods, templates, etc.
2. Establishment and approval of a budget committee (list of budget control and decision makers).
3. Development of planning regulations.
4. Development of a budget model and identification of responsible persons (CFR).
5. Developing methods for monitoring and responding to deviations.
6. Implementation of a budgeting system.
It usually takes several months to implement budgeting. In order to maximise the convenience and efficiency of the process, we recommend automating the process during implementation.
What is the procedure for developing and approving the budget?
The budget is drawn up and approved in the calendar/financial year (with a monthly breakdown). A budget committee is convened monthly, on the first days of the month following the reporting month, to review performance against plans and adherence to the approved budget.
As noted previously, the budget consists of two parts: revenue and expenditure.
- Revenues shall be itemized by groups or types of goods/services (SKU).
- Expenditures shall be itemized according to the unit's cost items approved by the Regulations and the budgeting model.
Please note! CFRs often combine different cost items into one with a common name, e.g. Other operating expenses. We recommend avoiding such common titles as they:
- do not allow an easy understanding of the nature of the costs incurred;
- allow CFRs to "hide" inappropriate expenditures (which management has not allowed funds to be spent on).
Who makes the budget?
The Head of the CFR is responsible for preparing the budget (unless otherwise stipulated in the Budgeting Regulation). The draft budget is prepared based on analytical data from previous periods or the own assumptions of the head of the CFR taking into account the targets set by the owner.
Note. The owner, as the ideologist of the business, has a vision of achieving certain KPIs for the company, so s/he is the one who decides on the revenue target to be achieved by the company (unless otherwise stipulated by internal policies).
Revenues are budgeted using the top-down planning method - management sets the targets to be achieved by the department.
Concerning expenditure, it is usually budgeted using the bottom-up method - the department, having received the revenue targets, understands what is needed to achieve the target and budgets for that expenditure.
Who approves the budget?
The budget is approved in several stages:
1. Approval of the budget of the CFR by the CFO.
At this stage, the heads of the CFRs present the draft budget to the CFO. The latter analyses its financial soundness, asks clarifying questions, and approves or rejects it for revision.
2. Approval by the CEO or owner of the budget of the company.
At this stage, the financial director presents the budget of the company (as a whole) based on the approved budgets of each CFR.
Budgeting automation helps to:
- facilitate the process of obtaining information for decision-making;
- reduce the risk of technical errors (if budgeting is done in Excel);
- set expenditure limits (CFRs cannot make budget overruns without the approval of the finance department or the owner);
- facilitate analysis of plan-fact characteristics;
- ensure convenience of obtaining data for previous reporting periods (for budgeting subsequent periods).
The owner's benefits from the implementation of budgeting
- the ability to clearly and understandably (in numbers) show the plans to be achieved by the company and each department/employee;
- the ability to transfer responsibility for budgeting and compliance to the CFRs (financial responsibility centers - departments);
- the ability to easily monitor the company's financial performance and understand its comparability with the company's goals;
- the ability to easily forecast the tax burden and respond to its optimization promptly.
If you want to consider budgeting as a method of financial management, our experts will be able to design a project for you and calculate possible improvements.