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Budgeting might not be the funnest thing in the world, but oh-boy is it important. Without a budget, a business is a ship without a rudder. A hiker without a compass. In other words, a budget provides an acute sense of direction and context to operations.

Unfortunately, budgets don't fall out of the sky fully formed. They require time and effort, not to mention a keen understanding of your business segments, operations, and performance. So to give you a headstart on the countless benefits a dependable, relevant budget can provide, we're going through the budgeting process with a fine-toothed comb, sharing insights and best practices as we go. So on that note, let's dig in.

Business Budget Planning Worksheet

What Is the Budget Process?

It's probably best to begin with the focal point of the budget process – the budget itself. Yes, this is Finance 101 territory, but it's always helpful to start a discussion by establishing a baseline.

Not coincidentally, that's precisely what a budget is – a baseline. Between your financial reporting and forecasting, you're telling a story based on your company's operations and finances. And like any hearty narrative, your budget provides the back story you build from. In that sense, think of your budget as Act I exposition that you expand on throughout Act II and III through forecasts, allowing the story to evolve as additional information comes in.

To put it in less metaphorical terms, your budget is a financial plan for your organization, a roadmap that lets you compare your upcoming fiscal year with particular targets you set for yourself. Granted, that's an oversimplification of things, but given the topic du jour, our focus today isn't so much on the concept of a budget but rather on the process of building one. And as you'll see, that's where things can get complicated.

 

Why Is the Budget Process Important?

Diving in a bit further, the budget process is essential because it fosters internal communication across different stakeholders, the Board of Directors and management on the outlook for your business.

That said, when either beginning or refining a budget process, it's important to remember the budget itself is specific to several factors, including your industry, company needs, and where you are in the business lifecycle, amongst countless others. Therefore, as we're bound to repeat in these musings, what might make for an effective budget and process for one company could be completely ineffective for another.

Still, despite the need to customize your budget process to your operations and objectives, it will always speak to something broader than finance machinations. In other words, the budget process is a golden opportunity to take a wide-ranging look at your company's road ahead, one that encompasses new contracts, products, services, and customers, along with past performance and insights.

For example, the mere act of creating an annual budget forces you to figure out how you’ll finance and support operations in the coming fiscal year. Similarly, the budget process helps you set compensation targets since salespeople and executives are often compensated based on performance against goals established in a budget.

On the capital allocation front, cash flow details within your budget let you look for the right places to invest your capital. Alternatively, suppose market conditions are deteriorating due to a global pandemic, a burgeoning recession, rapidly rising interest rates, or general economic disruption. In that case, your budget might reveal a deficit for the next fiscal year. Therefore, a well-planned, nuanced budget can identify the need to finance a portion of your operations well in advance.

To paint with a broader brush for a moment, budgeting also helps you identify areas where you're thriving and operating at a surplus, while also spotting expenses that are out of whack. Thus, on top of being a baseline for your operational narrative, the annual process of developing a budget allows you to continually make improvements based on lessons learned in prior years.

 

Budgets and Strategic Planning

We don't want to give the near-sighted impression that budgeting is exclusively a shorter-term exercise. Yes, at its roots, a budget focuses on establishing a baseline and performance targets for the upcoming fiscal year. However, the budgeting process can also have significant strategic value for companies that take advantage of it.

It’s standard practice for leadership to sit down every few years and figure out where they want the organization to be in both the short-term and long-term future. Getting from point A to point B will depend on different projects and initiatives that, collectively, become an organization's growth strategy.

New products or service lines will be fueling that growth strategy, creating the need to build them into the budget. The annual budgeting process takes these factors into account, building a pathway so the company can incrementally move forward toward leadership's strategic vision. From a broader perspective:

  • What percentage of revenue growth will come organically?
  • How much growth will innovation drive?
  • Who is involved in these activities?
  • What will the operational expenses be to get you there?

 

The answers to these types of questions should be within the annual budget, ultimately providing guide rails for capital expenditures (CapEx). Ideally, you want your long-term growth strategy and annual budget to work together toward the same unified goal. Just remember that it's not a perfect process, and there will inevitably be misalignments between your strategy and chosen budget processes.

As an example, let's assume your strategy is to focus on certain areas of your business. Although we’ll dive into the specifics in the next section, a bottom-up budgeting process lends itself well to this objective. However, after rolling up your individual business segments’ budgets, the results don't align with your overarching strategy. Therefore, something needs to change, maybe your inputs, how you're rolling up the departmental budgets, or even the budget model you're using.

The bottom line – your budget is a rule of thumb, not an absolute. If you try to align every data point or KPI (key performance indicator) to the cent, you're most likely burning time and resources that you could better spend elsewhere. Once again, an annual budget is a baseline you refine with subsequent forecasts as additional data comes in. Yes, you want to be in the ballpark with your budget, but chasing perfection is like trying to catch the wind. Futility personified.

 

Budget Methodologies

Now that we have the high-level insights out of the way, let's roll up our sleeves and start digging into the actual budgeting process. And we're going to begin by looking at three of the most common budget methodologies – the bottom-up, top-down, and zero-based budget.

Bottom-Up Budgeting

As we mentioned previously, a bottom-up approach to the budget process focuses on individual business segments establishing their own budgets. Once that first step is complete, you then combine these individual budgets upward to the organization level, collecting them in the corporate P&L.

Given how common a bottom-up budgeting process is, we'll use it as our foundation when discussing how to build a budget in just a little bit. For now, however, just remember this approach starts at an organization's bottom – departmental – levels and then rolls its way upward.

As you might've guessed, a top-down approach to the budget process works in the opposite direction as a bottom-up, beginning at the top of the organization and then pushing its way down to the different business segments.

As such, top-down budgeting tends to be the highest level of the three budget types we're focusing on, typically using generic business drivers. Therefore, while a top-down process is probably the most common, it's also the least accurate of the more popular budgeting types.

Top-Down Budgeting

As you might've guessed, a top-down approach to the budget process works in the opposite direction as a bottom-up, beginning at the top of the organization and then pushing its way down to the different business segments.

As such, top-down budgeting tends to be the highest level of the three budget types we're focusing on, typically using generic business drivers. Therefore, while a top-down process is probably the most common, it's also the least accurate of the more popular budgeting types.

Zero-Based Budgeting

A zero-based budget is unlike the previous two we've discussed. With this approach, rather than using the prior year as the baseline and then inflating or deflating the figures as needed, you literally start from scratch with the different business units.

Thus, a zero-based budget depends on each department head justifying their budget requests for the coming year. Granted, a zero-based approach is the heaviest lift of the three since it can be very work-intensive, but it can also provide much more granularity to the resulting master budget.

A Blended Approach to Budgeting

Of course, no two organizations are exactly alike, so relegating everyone to just three budget methodologies may not be appropriate. That said, while we don't want to take too deep of a dive and scare you away from what's already a hefty set of insights, we also want to convey a more nuanced approach to budgeting.

A blended approach can offer a flexible yet thorough and detailed budget process. For example, let’s assume your organization consists of business units and managers that consistently stay within their annual budget, save for a couple of troublemakers.

In this instance, rather than subjecting everyone to the additional time-consuming work and effort needed to complete a zero-based budget, you can save that more rigorous approach for those troublemakers, forcing them to justify their departmental budgets. For everyone else, the bottom-up approach will provide more detail than a top-down process while still being relatively more straightforward and convenient for segment managers.

You can also combine top-down and bottom-up budgeting when and where appropriate. In short, you’re not relegated to one or the other but can mix and match your budgeting processes according to your specific needs and financial goals.

 

How to Build a Budget

As we said, we'll be using a bottom-up approach as the basis for our discussion. However, as you’ll see, aside from the specifics of a particular budgeting process – i.e., bottom-up vs. top-down vs. zero-based – much of the following framework and sequence of events will work no matter what process or processes you ultimately choose.

Pre-Kickoff Planning

This is the beginning of the process, where FP&A meets with leadership to discuss high-level business activities that will affect the organization's budget. At this stage, FP&A should discuss any macroeconomic factors that might influence the budgeting process, revisiting any assumptions from the prior year when needed.

Likewise, it's also essential to identify areas where new business plans, segments, or a reorganization of business units will impact the budget.

Kickoff Meeting

With the high-level discussions said and done, FP&A uses a budget kickoff meeting to sit with department leaders and stakeholders to set expectations on the budget process. During kickoff, FP&A and leadership also communicate any macro business drivers the budget should account for, with FP&A documenting all preliminary and final budget deadlines.

The Corporate Budget Process

Naturally, this is the stage where there are significant differences between the three budget methodologies we previously discussed. However, focusing on a bottom-up approach, corporate groups should work through their respective budget assignments after the kickoff meeting, gathering inputs and models of their expected activity with FP&A's assistance as needed.

Drilling into that last point a bit further, FP&A should work closely with every business unit, answering questions and providing direction throughout the process. Otherwise, you're bound to have an avalanche of issues from the individual business units that will create a massive bottleneck and delay the entire budgeting process.

As a slight aside, dedicated budgeting and FP&A tools can be a real difference-maker as you aggregate the preliminary budget values from your business segments. The right solution will record and organize all of the data, making the entire process far more efficient and streamlined. As a result, it makes it much easier for the FP&A team to quickly and concisely present all of the budget assumptions, inputs, and targets for group leaders and executive leadership to sign off on.

With that all-important sign-off in place, FP&A can then review the budget assumptions and any preliminary outputs with the respective budget entity owners. Afterward, the CFO – and, later, the board – reviews the corporate budgets and provides feedback, the first point of an iterative process that goes back and forth with revisions between leadership and FP&A until the final master budget gets the final stamp of approval.

 

Budget Process Best Practices

To flesh out our quick run-through of the budget-building process, we also have a number of best practices to fill in the gaps.

Budget Assumptions

If the last few years have taught us anything, it's that change can come in torrents. At the macroeconomic level, factors like commodity prices, inflation, interest rates, exchange rates, taxes, tariffs, and more can drastically alter assumptions and inputs.

The same can be said for microeconomic factors like market growth, market share, new market entries, and industry-specific KPIs, amongst others. Combine all of these potential variances with changes to compensation and benefits, CapEx policies, and cost structures, and you're facing a mountain of assumptions that can change drastically from year to year.

Therefore, FP&A, the CFO, and other leaders must look at these different assumptions under a microscope, ensuring everyone's on the same page and the budgeting process properly integrates expected changes. Otherwise, the resulting budget will not serve as the dependable financial baseline it could and should be.

Business Segment Responsibilities

A bottom-up budget plan will only be as good as the different parts that compose it. Therefore, an organization's profit centers must adequately prepare for the process, beginning several months before year-end to prepare for next year's budget. This includes accounting for recent trends and run rates in the current fiscal year that will help inform the upcoming budget.

Similarly, individual business segments must also account for strategic and business initiatives – like digital transformations, for instance – along with any productivity improvements that will carry forward.

Communication Is Key

The budgeting process doesn't exist in a vacuum. It potentially consists of several stakeholders, from marketing and HR to IT and logistics. Any bump in the road across these different segments can delay the entire budgeting process, and that's no fun.

To avoid such catastrophes, it's imperative that FP&A – and leadership, when appropriate – communicate at every step of the process, particularly with those individual segments and stakeholders. Don't forget, the budget process is more of an organization-wide project than an isolated exercise for the finance department, particularly when following a bottom-up or zero-based approach.

Further, since business segments obviously understand their areas of operations best, be sure to include them in any discussions around assumptions for the next budgeting process. Likewise, after initial segment budgets come in, don't be afraid to go back and ask cost center leaders to refine their numbers when necessary. The FP&A manager or VP of Finance oversees this area, ensuring the segment operating budgets align with any initial assumptions.

Identify Key Business Drivers

Along with assumptions, it's important for FP&A and leadership to also identify key business drivers and how they might affect organizational performance. For instance, if we add sales people, how much should we expect revenue to increase per salesperson? And how much additional compensation would we have as a result? These are the types of insights FP&A can use to build out what-if scenarios and risk analyses after the baseline budget is in place.

Start with the Basics

If you're either new to budget implementations or trying to move from a higher-level, top-down approach to a more detailed and nuanced bottom-up budget, everything might initially feel a bit overwhelming. And that's okay.

Don't forget, you have to crawl before you walk, and walk before you run, so don't feel you need to immediately be an expert in a bottom-up or zero-based budgeting process. In fact, rather than getting caught up in the process itself, start at a more basic level. What do you sell? How much do you sell it for, and how many do you expect to sell next year?

If your business provides a service rather than a product, use the same line of questions around your utilization rates. Expanding on what we said in the previous best practice, this will help you identify your key business drivers, the fuel that propels your operations – and, thus, your budget – forward, so don't be shy about digging into them.

Organized FP&A Is Effective FP&A

Finally, as you've noticed by now, FP&A is steering the budgeting ship from port to port, guiding every stage of the process. Therefore, an organized FP&A team is absolutely critical to maintain an efficient budget process, beginning with the kickoff meeting.

In conjunction with leadership, start by understanding the scope of the activities the budget process needs to capture and include. These buckets of activities will differ between industries, so a services company will look quite different from a real estate firm which will vary from a manufacturer.

To keep all of these activities – and accompanying budget process deadlines – on track, we recommend creating a calendar or waterfall chart to depict the entire budget process visually. Typically, it's easiest to start from the endpoint and work backward, mapping all relevant processes and gauging the probable time needed for each action.

From there, FP&A can allot a proper amount of time for each process level. Additionally, you can plan for and include a cushion for known troublemakers, as well as identify any bottlenecks or critical steps early on that might otherwise lead to massive delays in the overall process.

As you go, keep in mind that public companies will have more extensive, stricter requirements than private companies, so some stages might take longer for SEC registrants. Likewise, take into account everyone's schedule, especially when presenting to the CFO and Board of Directors. In other words, don't expect a CFO to digest the corporate budget overnight. And if you need additional time at any given step or even miss a deadline, be sure to adjust any dependency deadlines to avoid massive traffic jams further down the budgetary road.

As we said up top, the budgeting process might not be your favorite thing to do, but it's essential to running a successful business. Therefore, with so much riding on your budget and forecasting process, don't be afraid to reach out and ask for help when needed. It's what we do best here at Embark, and we want nothing more than to help your organization succeed.

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