This is the eighth in a series of blogs on improving the corporate budgeting process. In the last blog I covered making people responsible for the things they can control. In this blog we look at checking budgets for realism. As budgets are developed, it's important to give them a reality check. There's no point in going ahead with a plan when it is patently obvious it's never going to deliver the goals that have been set. To avoid this situation there are a number of areas where budget figures can be tested to ensure they are realistic.
As explained in previous blogs, budgets enable a level of work to be performed to produce outputs. Reporting the budget in comparison with workload and outputs and contrasting with what is currently being achieved should reveal whether there are any significant changes. If there are then there needs to be a suitable explanation.
When setting large budget values for particular measures its worth asking the budget holder to break down the figure into more detail. For example, on marketing expenditure, get the manager responsible to break this down into things like the specific trade shows where they will exhibit, the number and type of adverts along with the media to be used, if known.
For revenue it might be worth breaking this down by the top 10 major customers and products. This level of detail should not be forced on everyone, but just for those items that are above a certain level. The benefit of this approach is that it provides fact-based evidence to back up the budget (and indeed a forecast), and allows a conversation to take place over the impact of intended actions.
There are two things that can be done here. The first is to plot key measures within the budget against the same time last year. This will help to see where increases/decreases have occurred which can then be the subject of an explanation. Deviations could be due to ‘one-off’ situations that are unlikely to occur again, or falling/rising prices that are a natural part of a product life-cycle. Second, is to plot next year’s budget as a continuation from this year’s actual/forecast data. What we are looking for is whether the trend makes sense. Quite often budget items like sales have a ‘hockey-stick’ effect towards the end of the year that isn’t borne out by previous seasonal trends. We are also looking to see if there are any step-changes from actual to budget as typically happens. For both an abnormal trend or a step-change in performance, there must be a reasonable explanation as to why this is the case or some doubt must be put over the validity of the budget numbers.
A more advanced technique is to use statistical analysis to uncover seasonal and other trends to predict what may happen in the future. This prediction is then contrasted with the budget submitted to give an indication of the statistical confidence. This type of analysis only works for items that are seasonal or where there is a defined ‘cause and effect’ link. It’s also worth remembering that the predicted trend may not be right as all trends come to an end at some time, but it is another method that can serve as a basis for a conversation regarding the realism of the budget.
- Produce trend reports for the current year that contrasts this year’s performance with last year and the current budget.
- Determine at what level of income/expenditure requires a detailed analytical report or breakdown.