A contribution by Dr Christian Wurditsch - Entrepreneur, Investor, Business Angel
Everything you need to know about budgeting and creating realistic budget plans
(or what a budget or financial plan has in common with a hiking map)
Fact box for people in a hurry
- Budgets are important
- Anyone can do budgeting
- Realism is a key to success
- Software supports immensely
What is budgeting
Budgeting (also budget planning, financial planning) is the business planning process used by business entities to create a budget. Budgeting defines certain targets that are to be achieved within a planning period (usually 1 year in companies).
The goal of budgeting is thus to depict the planned future in the form of figures and to record them in the budget.
Budgets are prepared for private households (budget) and companies (budget), but also for public institutions, from municipalities and federal states to the state/federal government (budget), and form the basis for measuring performance and monitoring success.
What are the different types of budgeting?
There are many different types of budgeting. Here are a few examples:
- Operational budgeting
- Strategic budgeting
- Retrograde budgeting
- Progressive budgeting
- The countercurrent method
- Divisional budget planning
- Programme-related budget planning
- Zero-Base Budgeting
In addition, there are fixed budgets and flexible budgets - classification characteristics such as the budget unit, the target size, the reference period, the flexibility and the determination method result in further variants of budget planning.
Let us briefly look at the characteristics of the types of financial planning mentioned.
Operational budgeting
The objective of operational budget planning is to prepare short-term budgets that serve to plan and control the available financial resources for a period of usually up to one year.
Strategic budgeting
In contrast to operational budgeting, which is done to prepare short-term budgets (monthly, quarterly or half-yearly and annually), strategic budgeting is used to plan long-term budgets. Goals and targets are set for a period of up to 10 years.
Retrograde budgeting (top-down)
In centralised retrograde budgeting, the preparation of the budget starts with the management and is broken down to the respective smaller organisational units.
Progressive budgeting (bottom-up)
In decentralized progressive budgeting, budgeting begins in the smallest organizational units in the form of sub-budgets or sub-plans (sales plan, turnover plan, personnel plan, investment plan, Cash flow plan, material plan, marketing plan, etc.) and is combined (aggregated) at the highest level to form an overall budget.
The countercurrent method
Counterflow budgeting combines retrograde and progressive budgeting to take advantage of both types of budgeting and eliminate weaknesses.
Divisional budget planning
In area-related budget planning, the existing resources are generally taken as a basis. This is referred to as input-oriented budget planning, which is usually based on past experience.
Programme-related budget planning
Programme-related budget planning is usually oriented towards the goals to be achieved. In this context, one speaks of output-oriented budget planning, in which the required resources for the bundle of measures to achieve the output are first derived.
Zero-Base Budgeting
In zero-base budgeting, the budget is planned from scratch, in contrast to the usual planning, which is based on the current budget. Each department defines different measures for the coming period and the total budget is allocated to the respective measures according to priorities. Due to the constant rethinking of the measures, this is a very efficient form of budgeting.
Now that we've covered the basics of budgeting, let's look at what you should know about budgeting and creating realistic budget plans.
2 Questions we are often asked about budgeting:
- What are the steps in effective budgeting?
- How do I ensure that my plans, especially the all-important liquidity plans, are as realistic and useful as possible?
Here are our thoughts on it.
What are the steps in effective budgeting?
Depending on the type of budget planning, different and varying numbers of steps are necessary to create a budget. For traditional budget planning, ten individual steps are necessary.
- It is determined whether there are significant changes in the company, company goals, resources, etc. compared to the previous financial plan.
- A forecast is made of factors relevant to the budget. The data of the past period serve as the basis for the forecast.
- Budget targets for the enterprise are set. The data and information determined in points 1 and 2 serve as a basis.
- An overall budget is proposed - usually by the management (top-down).
- Individual budgets are planned by the decentralised planning departments (bottom-up).
- The budget requests of the decentralised planning departments are passed on to the next higher authority.
- It is checked whether the budget requests are compatible with the specified form targets.
- The budgets or sub-budgets planned or proposed by the management and the decentralised planning units are reconciled.
- An overall report will be prepared.
- The overall report is reviewed by the management and the overall budget is approved if necessary.
How do I ensure that my plans, especially the all-important liquidity plans, are as realistic and useful as possible?
Take time for planning - It's a worthwhile investment
First of all, you should be clear about why you are making a budget. The answer has a big impact on your attitude and therefore also on the attention you pay to the budget process. First of all - a budget, or in other words financial planning, is important for every company. For entrepreneurs in particular, however, Cash flow planning is essential in this context. Nobody sets off on a hike in unknown areas without a map or navigation device. The budget is the company's route plan through the year. You set goals and make assumptions in order to arrive at the end of the year where you want to be as an entrepreneur.
Here's an EXPERT TIP: If you invest time in creating a realistic budget, it will help you prioritise in operations according to your specifications. In other words, you will know which way to go at the forks in the road. It will also make it easier to determine where you stand along the way. In classical business management, this is called controlling.
Use the previous year's figures - but only for guidance
In budgeting, a distinction is made between two procedures. The top-down method starts with planning from the top and the planning is broken down to all organizational units. In contrast, bottom-up planning starts with partial budgets such as sales plan, sales plan or sales plan, production plan, personnel plan, investment plan, Cash flow plan from the organizational units. These sub-budgets are then combined at the top level to form an overall budget. The sales plan is usually the starting point. In contrast to zero-based budgeting, the first step in both budgeting methods is usually based on the previous year's figures. These figures from the previous year are often a good first indication of expected sales and costs and are a hallmark of efficient budgeting. This is often referred to as a base plan. This should then be the starting point for the priorities in the current financial year.
Here is an EXPERT TIP: On this basis, consider your sales plans, what additional costs you are planning compared to the previous year and what investments you would like to make. This helps with motivation and also with the coordination of your decisions.
Make realistic plans - a lot of things will be easier that way
In addition to operational behaviour control, budgets also serve to identify problems and have an early warning function. To this end, it is important to strive for a realistic budget. No one can predict the future, but you can prepare and you usually have experience. Therefore, make sure your plan contains enough information to easily monitor the key drivers of your business such as turnover, costs and working capital.
Here is an EXPERT TIP: Proceed according to the 80 / 20 rule. Invest time in your most important planning positions. If you don't spend so much time on smaller or less important budget items, you can think more about the sales offensive and its impact on the figures. Always keep dependencies in mind. If you want to make more turnover, this usually leads to higher costs, such as more material purchases, the purchase of external services and more personnel, and this should be reflected in the corporate planning.
Involve the right people - together you get further
In many companies, there is often the prejudice that budgets are mainly something for controllers with a love of detail, that they are a nuisance or restrictive to work with. Entrepreneurs, managing directors, managers and employees usually overlook how important it is to march through the company year with a coordinated "walking map". This common picture is important in order to bring the forces and decisions into the same alignment during the various challenges such as climbs, forks in the road or river crossings.
An EXPERT TIP: Planning should always be a team effort. Plans developed together have a higher probability of being achieved and automatically lead to higher commitment. The team understands your priorities and you gain insight into the thinking of your staff.
Characteristics of good operational and strategic budgets
- Budgets must reflect clearly defined responsibilities
- Budgets must be measurable and flexible
- Budgets must have room for manoeuvre for the respective responsible person
- Budgets must be realistic - thus challenging and achievable
- Budgets are team efforts and not ivory tower results
- Budgets are not an end in themselves but provide guidance for important decisions
Use a tool for support - The added value is great
You should use a software tool for plan development and subsequently for controlling. Often the accounting system is used here. However, this has the disadvantage that the entire complexity of accounting is usually represented in it and accounting is primarily designed to document the past. Corporate controlling on the basis of accounting is like route planning when driving a car on the basis of motorway toll receipts or fuel receipts and not on the basis of the real-time data of a navigation device.
Our EXPERT TIP: In 2019, budgeting should be done with state-of-the-art support, which does not necessarily include Excel. COMMITLY is the flexible, supportive online tool here. COMMITLY makes it easy for you to create, reject and fix plans online and to continuously monitor the achievement of the plan.
False myths about budgeting - leave prejudices to your competitors
- Budgets are out-of-date - think of budgets as navigation devices or walking maps in digital form. They are used more than ever.
- Traditional budgeting processes are time-consuming and inefficient - pragmatism and modern software tools reduce the effort to a minimum and increase the insights many times over
- Control on the basis of budgets takes place once a year - State-of-the-art corporate control happens on real-time data and is part of the daily corporate success
- Budgets set the wrong incentives - budgets created in teams create responsibility and orientation for managers and employees
- Budgets nip innovations in the bud - Living budgets show potential and serve as early indicators for doing things better and differently
Our EXPERT conclusion
Budgeting is an important process for ensuring the vitality of an enterprise. Jointly created budgets are worth a lot in the operational management of companies. Modern online software tools allow updating at the push of a button, joint creation and editing of plans and support the implementation of budgets, for example in the form of forecasts. In comparison, Excel is a relic from the last decade.