Often, when people think of budgets, images of CPAs and CFOs come to mind. They’d assume leave the numbers to those with the titles and letters following their names. However, in reality, budgets are for many more than just those with accounting backgrounds. In fact, all
individuals with any spending authority in an organization should be comfortable bonding with the organization’s budget.
A budget is an invaluable tool to help individuals make well-informed decisions based on actual numbers, rather than hypotheticals. With those decisions, individuals can guide the organization strategically through each quarter and fiscal year, with a clear picture as to where the organization stands and in which direction it is heading. The budget creates a detailed road map to help navigate through expenditures and forecasts.
Ultimately, there are three primary budget considerations for any organization:
1) More People Involved from Inception. Each person who authorizes an expenditure in any way, whether it is signing checks, approving invoices, paying bills, or some other task affecting financials, should participate in the budget preparation process and the monthly budget review. It is critical that they are involved in the budget process from inception, or are brought up to speed as quickly as possible. Often, when I ask someone who is in charge of expenses why the budget to actual is off, they respond that they have no idea how the budget was put together in the first place. How can anyone expect these individuals to properly manage expenses when they are unaware of the principles behind them? This is easily solved when the individual is involved from the beginning.
2) Alignment of Budget and General Ledger. The budget line items and categories should be identical to those in the general ledger. Accounting and finance teams need to focus on analyzing differences at month-end, not inputting, exporting, and manipulating data merely to get it to the point where they can analyze it. It should all be organized in the same way from the start. For example, a property and casualty insurance company may have their general ledger categorized by type of customer, while their budget is categorized by their annual statement (the document each insurance company is required to file with the state of domicile). Varying methods of organization requires increased allocation comparing the actual results with the budget, resulting in misspent time and resources. To make matters worse, through this time-consuming process, an organization lacks the critical information needed to pivot at a time of crisis. For example, when a country’s entire economy shuts down due to a global pandemic.
3) Accounting Alignment. The accounting in the budget analysis and the general ledger should be the same by department. One common issue occurs with payroll. Oftentimes, payroll is run every two weeks and recorded on a cash basis in the general ledger, but on an accrual basis in the budget. For example, if an employee gets paid $120,000 per year, the budget would allocate $10,000 per month for payroll, while the general ledger would show $9,230 for two payroll months and $13,846 for three payroll months. It would never match. When budget to acutal analysis is presented to the management of the organization, there should not be time for an explanation of the accounting differences in the budget and actual. Rather, the conversation should be 100% focused on maintaining alignment with the strategic goals that were established when initially creating the budget.
Other benefits of proper budget management include, empowering more employees to make better decisions for the organization, saving money over time, curbing spending, and increasing preparedness. Additionally, when the budget process is carried out properly, it can reduce fraud. Once the person authorizing the expenditure understands that someone will be carefully analyzing the details for which they are responsible, they will be less likely to steal from the organization.
While many people would rather push off the numbers, columns, and formulas of the budget process to someone else, it’s really the last thing they should do. In fact, when they are involved in the process, they will understand all of the components and essential information on a more comprehensive level. In doing so, they not only create a stronger bond with the budget, but also create a stronger bond to the organization itself.
If you would like to discuss your budget and how to ensure it is working efficiently for you, or if you have other specific areas of concern, please click here to schedule a 30-minute free consultation.
Category Archives: budget
It is the first month of the calendar year and for many, the start of the fiscal year as well. The first month for you to start measuring the results you assuredly planned and documented in a budget for the year.
Each of you has a different relationship with your budget. Each of the components of this relationship can lead to great results or negative ones, depending on how you react to them. Your reactions can impact your personal career as well as the health of the company you own or work for.
Read more about some of the pitfalls of budgeting and how to enhance your relationship with the budget to achieve the great results for which you planned.
CEOs, Presidents and Executive Directors
If you created the budget while sitting with your accountant, made sure you were comfortable with the revenues and expenses, but have not communicated it to the managers and leaders of the organization, you have just cheated on your budget. My counsel is to get the budget in a presentable format to communicate to those who have a chance to manage day-to-day to help you achieve the results forecasted in the budget.
The message to your managers should include your overall strategy, backed by practical, measurable goals. Your leaders need to believe in your strategy because if they do, your job of leading the organization to positive results will be so much easier.
I repeatedly hear, in large and small organizations, from managers, supervisors and those on the front line, that they have no idea what the monthly budget is for repairs to equipment, printing costs, etc. They are spending money based on one decision at a time without the benefit of the overall strategy. Without involving your managers in the process, you are not benefitting from their knowledge and experience.
Nonprofit Executives and Finance Committee Members
Can you answer these questions? If not, your budget package needs work.
- How much does it cost the organization to run each program? Of that total cost, how much is covered by actual funding commitments and how much has to be raised to maintain the program(s)?
- How much of your administrative cost – Finance, Accounting, Development, etc., is funded by direct reimbursement and/or the de minimis administration expense reimbursement in grant budgets? How much money has to be raised to cover these costs?
- Does the budget package have one column for the Net Change in Assets/Income Statement and no backup schedules to show the Revenues and Expenses by program and grant? If your answer is yes, the budget package is one-dimensional. In other words, it does not provide the fundraisers and the Board the needed information to interact with potential donors and speak intelligently about the real needs that are met through fundraising. Many nonprofits go under when they issue one dimensional budgets to Finance Committees year after year. There is no clear understanding of the true funding requirements. Your fiduciary responsibility should lead you to ask for more transparency regarding where the needed funds for programming and administration costs will come from.
Finance and Accounting Professionals
Did you manage the budget process so that the budget is constructed the same way the detail accounting entries are made month-to-month? Most non-finance professionals hate to deal with anything that has “Budget to Actual Variance” in the description; add to it that you are explaining that the variances are because the budget has one type of accounting and the actual has another, and you are sure to cause irritation that is just not necessary. It is like a spouse putting the toilet paper on the roll backward – it is irritating and just not necessary. It is your job to keep the conversations and analyses about real differences and tie those differences to a real discussion that empowers the team to react and strategically move the direction as planned or make a decision to pivot. Here are some pitfalls to avoid:
Differences Between Finance and Payroll Practices
Large and small organizations find themselves with the ineffective comparison of budget-to-actual salaries, caused by Finance dividing the total annual salary by twelve for the monthly budget. Payroll records the true payroll expense. Month-to-month variances result, as Finance budgeted for a full twenty-eight to thirty-one days and Payroll budgeted for twenty-eight or forty-two days depending on whether it’s a two or three pay period month.
Insurance is typically paid in advance for the quarter or year. If it is material, it should be set up in a Prepaid Account. If insurance bills are expensed as paid, the month variance could be a result of those payments and not an actual expense overage.
Annual payments for subscriptions
These payments should be reviewed to determine materiality; determine if they should be set up in a prepaid account when paid, or if they are immaterial and should be expensed. When you mirror the actual accounting and the anticipated expense pattern in the budget you can avoid unnecessary variances and questions.
A company that is anticipating a large increase in revenue should determine how the increased sales and related cost of goods should be spread throughout the year in the budget. Consider the current pipeline and sales cycle when budgeting sales revenue. If your sales cycle is 120 days and there is $1 million in your pipeline at the end of the year, you will not realize $3 million in sales in the first quarter. A fast-growing entity could possibly reach $12 million in sales for the full year, but it should not be spread evenly to each month. Patterns such as this will frustrate executives and sales staff and make them feel like failures. This would be the equivalent of us expecting our spouse to be Jeff Bezos and to increase our family’s net worth at the same rate.
Make sure you are empowered with the right information to effectively run your department. Do your best to work with accounting to submit invoices and information within their deadlines so they can process the data into information that you can review and use to communicate effectively with the leaders of the organization.
Try to manage potential budget cuts made throughout the year so the troops can stay focused on driving the overall strategy of the business.
Think of it like this great example in the Netflix series House of Cards (spoiler alert if you have not begun your binge watching of the series – sorry).
In this episode, Frank becomes President and wants to take funds from FEMA to fund a jobs program to put people to work. The head of FEMA does not resign and tells his colleague he is not going to resign, as he is the only one who can manage the reduced funds and help those in need if a hurricane does hit after Frank took all the budget money. While the drama is critical for a successful Netflix series, you don’t want a similar drama playing out in your company!
Good luck with your relationship with the budget. Use my advice to help manage your fiduciary responsibility to the organization, as well as your duty to manage your career. Avoid the many aspects of “marital irritation” I have discussed by correctly managing Budget-to-Actual variances.
If you would like to discuss your relationship with your budget directly with me, please sign up for a complimentary 30-minute session through the contact link here.
experience I have found that whether you are a new business owner or an experienced CEO, it’s easy to overlook some basic controls in your organization to detect and prevent fraud. I’ve put together six practices you can…and should…implement if you have not done so already.
Read further at The CEO’s Guide to Fraud Prevention.
As new entrepreneurs become caught up in day-to-day survival it’s easy to overlook these four practices that support the long-term strategic growth of the new business:
- Annual budget
- Business plan with 5-year forecast
- Planning for leadership evolution
- Impact of decisions on cash flow
Let’s start with budgeting. The key to survival is measuring and monitoring the results. It is essential to complete an annual budget, break it down in monthly components and monitor each month. The budget should include an income statement, balance sheet and cash flow. Most companies have an income statement; however, I have seen fewer balance sheets and cash flow projections. This can really get you in trouble as you will not have any line of sight to your working capital needs. Working capital is the cash you need to run the business.
For example, if you sell goods, chances are you will need to spend money on inventory prior to selling the item and recognizing revenue. If you have projected your sales to increase by 25%, you may have painted a lovely picture of growth with your projected income statement that is not reality if you do not have the cash to purchase the inventory to sell because you have not projected the use of cash to purchase the inventory, which is what the balance sheet and cash flow projection are for. This can really get you into trouble, especially if you have inventory on your balance sheet, but not enough cash coming in from sales to pay for it.
In addition to a budget, your company should have a business plan and a five-year forecast. The business plan should articulate the plan for your company’s growth and address anticipated changes in the economy and future trends. It is difficult to predict all of these things, but if you develop a robust business plan, you are thinking through the different scenarios and how these scenarios will impact your business.
Think through leadership, including yourself, as your company grows. Clayton Christiansen* of Harvard Business School, says managers who are talented and skilled in the area of productivity and squeezing out the last bit of value from a company’s assets, are usually not the same people who are great at innovation and major change. Often a successful manager replaces the person who is responsible for helping the company become successful when the company becomes mature enough to establish systems and balance checks.
It is imperative to think through how decisions you make can impact cash flow – and here is why. I worked with an organization a few years ago that historically had double-digit growth each year and was very profitable. The initial product the business launched was a great success because it was much better than anything on the market. The company was getting ready to launch a second product. At my first management meeting they discussed how the product was on its way to the warehouse, noting they had offered extended payment terms to customers on their entire order if they added the new product to their order. No one had projected the impact this decision would have to their balance sheet and cash flow, so they were unaware that the plan they had in place was going to essentially stop incoming cash – and they had just signed up for a huge payable to the vendor. We had to react quickly and manage cash to meet payroll and other obligations. Such a decision caused a 5-6 month stressful time, requiring we run cash flow projections daily during that time to ensure obligations would be covered.
Unsure how to get started on these four critical processes to help with your growth? Contact Mindy Barker & Associates to find out how we can assist with the process.
* Clayton Christiansen is regarded as one of the world’s top experts on innovation and growth. He is the Kim B. Clark Professor of Business Administration at the Harvard Business School, where he teaches one of the most popular elective classes for second year students, Building and Sustaining a Successful Enterprise. – See more at: http://www.claytonchristensen.com/biography/#sthash.jS5zzfLx.dpuf
As a cost center owner, have you found yourself being asked to approve expenses, but you have no clue where they came from? You know you have a budget, but do you truly understand how it was developed or how you are supposed to work with it on a daily, monthly, quarterly and annual basis?
In the course of the budgeting process, an isolated group often prepares budgets in a vacuum, failing to include the right people in the process. This leads to confusion and frustration when the budget-to-actual expense is compared each month. I have often experienced meetings where budget-to-actual variances are discussed and the manager approving the actual expense (a) has no idea how the budget was prepared and (b) cannot answer any questions about the budget-to-actual variance for the month. This leads to the Board, President and Senior Leaders reviewing and approving a budget based on inaccurate information. They may have unrealistic expectations when planning for the next year as the expenses budgeted in each cost center is inaccurate. Make sure your budget process is well planned out and includes all the responsible parties.
Please contact me if you would like to have your budget process reviewed to learn how to include all of the right contributors, avoid setting unrealistic expectations and finding surprise variances each month.
Why is Preparing a Budget Without a Balance Sheet and Cash Flow Like Driving a Car in a New City with an Old GPS?
Cars built in the early 2000s that had a built-n GPS required periodic updates using a CD with new roads and street addresses. If you are still driving around with a GPS of that era, you already know that when you get to a new construction area, the GPS will confuse you more than help you get to your destination. This analogy is similar to preparing an annual income statement for a budget without updated information. The annual income statement will show the projected revenue and expenses – but will leave out critical pieces of information vital to the day-to-day planning of a business. Here’s an example of what I mean: revenue is highly seasonal but expenses are spread throughout the year, causing issues with covering expenses month to month. Actual cash flow and the ability to cover debt service payments are not analyzed solely with an income statement. Another example: internally developed software can cost a lot of money; the cash required for the development is maintained on the Balance Sheet and not the Income Statement.
Lack of proper planning and analysis, and failure to prepare a projected-by-month Income Statement, Balance Sheet and Cash Flow can lead to an unplanned cash crisis. Please contact Mindy Barker & Associates if you would like to have your budget process reviewed to determine how you can avoid such crises each month.