An Interesting Approach to Budgeting

The budget process is not just putting together an estimate of the spending for next year, or estimating what the income will be.  It is a business planning process and control tool for the management of an organization.

The objective of the planning process could be viewed as establishing the profit goals of the organization; but, it also allows commitment to shareholders, and provides a degree of predictability.  Companies that want to be safe, high yield investments or want to remain safe, high yield investments require control and a high degree of predictability.

Five Objectives of the Planning Process:

1) Ensure consistency between strategic objectives and business planning
2) Ensure the rational allocation of resources
3) Support a continuous improvement process
4) Add value to Management's investment of time
5) Increase fiscal responsibility within the organization

A large US company applied an interesting and very successful approach to the budgeting process; in that, they applied a ‘bottom-up’ approach to the process. 

(A ‘bottom-up’ approach, in summary, starts with the detail of expected or desired sales and costs and accumulates the budget from the detail.  A ‘top-down’ approach starts with senior management’s expectations, goals, statistics, or needs in setting an overall, high level budget.  The ‘top-down’ budget is then broken down into detail for company operating units.)

This ‘bottom-up’ approach naturally has significant input and influence from senior management, in that, goals, targets, and standards are applied in the preparation of the detail budgets.

Return to top

 The building blocks of this particular Planning Process is a ‘cost center’ structure that applies costs and expenditures into three functional classifications:  Baseline, Change-to-baseline, and Projects.

The ‘baseline’ is all expenses associated with running a cost center.  This means normal ongoing operational costs that might including:  salaries and benefits, travel and any other normal costs associated with running a particular cost center without increasing or decreasing its productivity or capacity.  ‘Ongoing’ means as long as the cost center exists.

The ‘change-to-baseline’ is an activity that impacts the cost center’s productivity or capacity, and increases or decreases its operational expenses.  These changes are changes that are considered as ‘ongoing’.  An example might be the hiring of personnel to meet the needs of sales expansion when the expansion is considered permanent or ‘ongoing’.  A reduction of personnel to meet a permanent change is also a ‘change-to-baseline’.  Marketing adds a new journal ad promotional program for a new product. 

In summary, changes to baseline are:
1) Increases or decreases to operational capacity
2) Planned growth or reduction in normal, continuing activities of cost center
3) Ongoing change in personnel, productivity, or spending levels that may result from Projects.

Return to top

The third classification is ‘project’.  A project is an initiative that begins and ends at a defined point in time.  Not all expenses impact a cost center’s operational expenses on an ongoing basis.  Some costs end at a point in time.  An example might be a consultant being hired to resolve a particular problem.  When the engagement is finished, the costs stop.  One-time costs are also classified as ‘project’. 

In summary project are:
1) Finite duration with specific purpose or goal
2) Have an implementation start date and end date when purpose is accomplished
3) Require use of manpower and/or expenditure of funds
4) Can span multiple functions and cost centers

This ‘baseline – project’ approach to budgeting has the advantage of focusing management attention on changes in the business planning and the management reviews.  Financial contribution of each incremental spending proposal can be evaluated and compared to other components of the plan.

Some of the key output of this type of planning process is:
1) A high degree of predictability.
2) Manager commitment and understanding of the planning process.
3) Provide management with an efficient tool to help manage expenses.
4) A cross-functional expense perspective, and
5) An expense infrastructure that supports the priorities of the business.

Key Drivers of the Process:
1) Setting targets that can cascade through the organization.
2) Establishing business priorities.
3) Developing in an efficient manner the cost center budgets.
4) Supporting business priorities keeping within the financial targets.

As a part of management strategy, the planning process and the support tools are designed to assist management in implementing planning goals and policies, in verifying compliance, and in applying discipline to the planning process.

The system that is implemented to support the planning process provides extensive automation in handling details, implementing standards, controlling timing, enforcing security, pre-calculating budgets based on standards and guidelines, automates error detection, what-if support, and communication of goals and results.  The process provides both budgeting and forecasting, and is able to offer an online comparison of budget and forecast to actuals data on a daily basis.

Being able to measure the budget and forecast process with timely actuals data leads to more reliability and a higher degree of predictability.

Return to top

---

This page last modified on
Email your comments to info@wpmc.com
Copyright: Williams & Partner, 2003