Build the Best Budget for Your Business

As we begin Q4 and near year-end, businesses should begin preparing for 2017. While many companies may begin aligning its workforce or implementing strategies around technology process improvements, now is the time to dive into budgets.

Budgeting and forecasting enables businesses to determine the right process and people improvements based on their individual growth plans, industry and life cycle. Just as the outcomes of the budgets and forecast may lead to different actions by the business to supplement or improve certain metrics, the type of budget varies as well.

Budgeting Basics

Two years ago, I co-hosted a webinar on the basics of budgeting, as well as how to begin building next year’s budget. Our topics included:

  • Why you should develop a budget for the upcoming year and how it will impact your profitability
  • When you should start building your budget for the upcoming fiscal year
  • The framework of planning and the data set you will need to plug in
  • The key company stakeholders that should be involved in the planning process

As vcfo, we have provided CFO consulting services for more than 3,000 clients over the years. I’ve seen first hand how year-end close can take priority over next year’s budget planning; however, now is the time to plan.

But before you can begin developing budgets and forecasts, you must the different budget methodologies—top-down, bottom-up and iterative—as well as their advantages and disadvantages. What type of budget works best for your company?

Top-Down

Estimates the cost of higher-level tasks first and uses these estimates to constrain the estimates for lower level tasks. To successfully implement this method, an important factor is the experience and judgment of those involved in producing the overall budget estimate. While the top-down method takes less time and doesn’t require multi-level participation, translating long-range budgets into short-range budgets can be a challenge.

Pros

  • Lower management better understands what upper management expects
  • Can be accomplished in a short time
  • Aggregate budget is quite accurate, even though some individual activities are subject to large error
  • Budgets are stable as a percent of total allocation and the statistical distribution of the budget is also stable, leading to high predictability
  • Small costly tasks don’t need to be identified early in this process since they are factored into overall estimate
  • Can be accomplished in a short time

Cons

  • Top management’s limited knowledge of specifics of project tasks and activities may lead to underestimation of costs
  • Can lead to competition for funds among lower-level managers trying to secure adequate funding for their operations
  • This process is a zero sum game as one person’s or area’s gain is another’s loss
  • Subordinate managers often feel that they have insufficient budget allocations to achieve the objectives

Bottom-Up

Identifies all constituent tasks involved in implementing a project and works out the resources and funding required by each. It provides the opportunity to create organization-level budgets and creates centralized project-level budgets from sub-project budgets. Managers have the flexibility to define their project budgets independently, and financial managers have the ability to centrally review the total project budget/s.

This type of budget seeks participation from all levels and encourages a commitment to the defined budget plan.

Pros

  • Higher accuracy of the budgets for individual tasks
  • Clear flow of information
  • Use of detailed data available at project management level as basic source of cost, schedule, and resource requirement information
  • Participation in the process leads to ownership and acceptance

Cons

  • Top management has limited influence over the budgeting process
  • Individuals tend to overstate their resource needs because they suspect that higher management will probably cut all budgets by the same percentage
  • More persuasive managers sometimes get a disproportionate share of resources
  • Much of the budget is created by junior personnel
  • Sometimes critical activities are missed and left unbudgeted

Iterative Process

Means “to repeat or do again.” The iterative process is a combination of top-down and bottom-up budget building. There is a higher project level (top-down) and a lower level (bottom-up) estimation of costs. The two estimations are compared, negotiated and reconciled.

Pros

  • Promotes employee involvement
  • Stimulates an increase in information flow between departments/profit centers
  • Both senior management and lower level management participate in the budgeting process

Cons

  • Relatively inefficient and time consuming nature of the negotiations over the budgets
  • May not work well when communication channels are either informal or blocked between lower-level managers and senior management

If your business needs assistance developing 2017 budgets and forecasts, as well as implementing solutions based on the findings and outcomes, vcfo is one of the top financial consulting firms, providing CFO services and financial consulting for more than 20 years.

 

Cristina is the Managing Director of vcfo Austin. An accomplished professional within the financial services industry, Cristina has over 20 years of financial and operations leadership experience and 7 years of CFO Consulting experience with vcfo where she has helped to customize solutions for clients who needed finance, HR and technology solutions. Throughout her career, Cristina has had the opportunity to work with companies in various industries and lifecycles–from start-ups to high-growth and mature businesses.