A recent poll found that only approximately one-third of Americans maintain a household budget. It is no surprise then that a large percentage of business owners do not maintain budgets for their companies either. The reason for this varies. It may be because a small company grew quickly and internal processes did not keep up, or it may be a company slowly grew over time but the original owners are uncomfortable with change. No matter the reason, business owners should understand the budgeting process is a beneficial resource that every company should implement.
A typical budgeting process should look like this:
• Management prepares a budget for a specified timeframe, using historical financial data (or applicable industry data, if available).
• The budget is communicated to personnel.
• Governance members develop a realistic plan in compliance with the expectations.
• The company’s governing body reviews the budget, goes over any questions with management, and assists with modifications.
• After all issues are resolved, the governing body officially approves the budget.
At a minimum, management should compare the results of various metrics against the approved budget and prepare an analysis annually - and in many instances, quarterly or monthly. Such analyses should be shared periodically with the governing body for review to determine whether changes should be made to improve future results.
Budget variances can be caused by external or internal factors, all of which affect business performance. External factors are influences outside of the management’s control that affect the business, while internal factors are influences that affect business operations because of management’s actions and/or the business environment. An external factor could be a general decline in a particular industry, while an internal factor could be a misconception made by management at any time in the process. Typically, with external factors, management should tweak the budget in order to adjust expectations. For internal factors that result in variances, management should implement changes in internal controls to better align the company to reach the approved budget goals.
In order to be effective, the budgeting process should be continuously managed throughout the operational life of a company. Additionally, as with any other process, follow-up is imperative. Management and the governing body of the business should coordinate regularly to ensure the appropriate action steps are occurring, are well documented, and are clearly communicated.