Budgeting – creating realistic budget plans

An article by Dr. Christian Wurditsch – entrepreneur, investor, business angel

Drawing up a budget is important and easier than you think

(or what a budget or financial plan has in common with a hiking map)

Fact box for those in a hurry:

• Budgets are important
• Anyone can plan their finances
• Realism is a key to success
• Software helps enormously

What is budgeting

Is the question “what does budgeting mean?” really that simple to answer? We say yes! It is also called budget or financial planning and is the business planning process by which economic actors draw up a budget. Budgeting is the definition of certain targets that are to be reached within a planning period (usually a year in companies). The aim is therefore to represent the planned future in figures and to set it down in a financial framework. These are drawn up for private households (household budget), companies (budget) and public institutions, from municipalities through federal states to the state or federal government (public budget), and form the basis for measuring performance and monitoring success.

What types of budgeting are there?

There are a great many different ways of creating a financial framework. Here are a few examples:

• Operational budgeting
• Strategic budgeting
• Retrograde budgeting (top-down)
• Bottom-up budgeting (progressive)
• Counterflow method
• Department-based budget planning
• Programme-based budget planning
• Zero-base budgeting

There are also fixed and flexible budgets. Further variants arise from classification criteria such as the budget unit, the target figure, the reference period, flexibility and the method of determination.

Let us briefly look at what is special about these examples.

Operational budgeting

The aim of the operational method is to draw up short-term budgets that serve to plan and monitor the available liquidity for a period of usually up to one year.

Strategic budgeting

In contrast to operational planning, strategic budgeting serves to draw up long-term financial plans. The goals and targets are set for a period of up to ten years.

Retrograde budgeting (top-down)

With centralised retrograde top-down budgeting, the budget is drawn up starting with company management and is broken down to the smaller organisational units.

Progressive budget planning (bottom-up)

With a decentralised progressive financing framework, the budget is drawn up starting in the smallest organisational units in the form of sub-budgets or partial plans (sales, revenue, personnel, investment, liquidity, materials, marketing plans and so on) and is then consolidated (aggregated) into an overall budget at the top level.

The counterflow method

The counterflow method combines the retrograde and progressive processes in order to use the advantages of both types of budget planning and to eliminate weak points.

Department-based budget planning

Department-based budget planning usually starts from the available resources. In this context people speak of input-oriented budget planning, which is mostly based on figures from past experience.

Programme-based budget planning

Programme-based budget planning is usually oriented towards the goals to be reached. People speak of output-oriented budget planning, in which the resources needed for the package of measures to achieve the output are only then derived.

Zero-base

With zero-base planning, the budget is planned again from the ground up, in contrast to the usual planning, which starts from the budget currently in place. Each department defines various measures for the coming period, and the overall budget is allocated to those measures in order of priority. Because the measures are constantly rethought, this is a very efficient method.

Now that we have covered the basics, let us look at what you should know about the actual process and about drawing up realistic budget plans.

2 questions we are often asked about the budgeting process:

1. What steps need to be observed in effective financial planning?

Depending on the type of planning, drawing up a budget requires not only a different number of steps but also different ones. Traditional budget planning requires ten individual steps:

1. Identify changes:

• Check whether there are significant changes in the company, in the company’s goals, in resources and so on compared with the previous financial plan.

2. Create a forecast:

• Draw up a forecast of budget-relevant factors on the basis of the data from the period just ended.

3. Set budget goals:

• Set the budget goals for the company based on the data and information determined in the first two steps.

4. Propose an overall budget:

• Company management proposes an overall budget (top-down).

5. Plan individual budgets:

• The decentralised planning departments plan individual budgets (bottom-up).

6. Pass on budget requests:

• The decentralised planning departments pass their budget requests on to the next level up.

7. Review the requests:

• Check the budget requests for compatibility with the formal goals set.

8. Reconcile the plans:

• Reconcile the financial frameworks or sub-budgets planned or proposed by company management and by the decentralised planning units.

9. Prepare an overall report:

• Prepare an overall report.

10. Review and approval:

• Company management reviews the overall report and, where applicable, approves the overall budget.

2. How do I make sure my plans, above all the all-important cash flow plans, are as realistic and as useful as possible?

Take time for planning – it is a worthwhile investment

First you should be clear about why you are drawing up a financial framework. The answer has a big influence on your attitude and therefore on the attention you devote to the budgeting process. That process is important for every business. For entrepreneurs in particular, cash flow planning is of essential importance. Nobody sets off on a hike in unknown territory without a map or a 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 as the business owner want to arrive.

Our expert tip: If you invest time in drawing up a realistic budget, it helps you set priorities in day-to-day operations in line with your targets. In other words: at forks in the road you will know which way you want to go. Beyond that, it makes it easier to work out where you are along the way. In classic company management this is called controlling.

Use the previous year’s figures – but only as a guide

A distinction is made between two procedures when drawing up a budget. The top-down method begins with planning at the top and is broken down to all organisational units. In contrast, bottom-up planning starts with sub-budgets such as revenue, sales, distribution, production, personnel, investment and liquidity plans, beginning at the individual organisational units. These parts are then brought together into an overall budget at the top level. Most start with the revenue plan.

Unlike zero-base budgeting, both procedures usually fall back on the previous year’s figures in the first step. These are often a good first indication of expected sales and costs and a hallmark of efficient cost planning. In this context people often speak of a base plan. This should be the starting point for the priorities in the current financial year.

Our expert tip: On this basis, take into account your sales plans, what additional costs you are planning compared with the previous year and what investments you would like to make. This helps with motivation and with coordinating your decisions.

Draw up realistic plans – it makes a lot of things easier

Besides steering behaviour operationally, budgets serve above all to identify problems and act as an early warning of bottlenecks. It is therefore important that you make an effort to produce a realistic financial plan. Nobody can predict the future, but you can prepare, and you usually have additional experience to draw on. Make sure your plan contains enough information to be able to monitor your company’s most important drivers, such as revenue, costs and working capital, easily.

Our expert tip: Follow the 80/20 rule. Invest time in your most important planning items. If you spend less time on smaller or less material budget items, you can look more closely at your sales push and its effects on the figures. Always take dependencies into account. If you want to generate more revenue, that usually also leads to higher costs, such as buying more material, purchasing external services and more staff. These aspects should be reflected in the business plan.

Involve the right people – together you get further

In many companies there is often a prejudice that budgets are mainly something for detail-obsessed controllers and are a nuisance or a restriction when working. Entrepreneurs, managing directors, managers and employees frequently overlook how important it is to march through the company’s year with an agreed “hiking map”. This shared picture is decisive for directing efforts and decisions the same way when facing various challenges such as climbs, forks in the road or river crossings.

Our expert tip: Planning should always be teamwork. Plans developed together have a higher probability of being achieved and automatically lead to greater commitment. The team understands your priorities and you gain an insight into how your employees think.

Good operational and strategic budgets should above all:

• reflect clearly defined responsibilities.
• be measurable and flexible.
• offer room to manoeuvre for the person responsible.
• be realistic and therefore challenging, as well as achievable.
• be team efforts and not results from an ivory tower.
• not be an end in themselves, but a frame of reference for important decisions.

Use a tool for support – the added value is considerable

For developing plans and for controlling, it is an advantage to use a software tool with practical features. The accounting system is often used for this. But that has the disadvantage that it usually represents the full complexity of accounting and is designed above all to document the past. Running a company on that basis is like planning a route while driving on the basis of motorway toll receipts or fuel receipts, instead of on the basis of the real-time data from a navigation device.

Our expert tip: Modern budgeting should take place with state-of-the-art support, and Excel does not necessarily count as that. COMMITLY is the flexible, supportive online tool here. It is intuitive to use, easy to integrate and offers numerous advantages. Budgeting, creating tasks, lists and plans, discarding them, fixing them and continuously monitoring whether the plan is being met – all simply at the push of a button.

False myths about budget planning – leave the prejudices to your competitors

• Budgets are out of date:
  • Think of budgets as navigation devices or hiking maps in digital form. They are used more than ever.
• The traditional budgeting process is time-consuming and inefficient:
  • Pragmatism and modern software solutions reduce the effort to a minimum and multiply the insights.
• Steering on the basis of budgets happens once a year:
  • State-of-the-art company management is based on real-time data and is part of daily business success.
• Budget targets set the wrong incentives:
  • Working out the financial framework as a team creates responsibility and orientation for managers and employees.
• Budgets nip innovation in the bud:
  • Budgets that are actually lived show potential and serve as early indicators for doing things better and differently.

Our EXPERT conclusion

Budgeting is an important process for safeguarding a company’s vitality, and budgets drawn up together are of great value when running a company operationally. Modern financial planning software such as COMMITLY allows updates at the push of a button, lets plans be created and edited jointly and supports the implementation of budgets, for example in the form of forecasts. By comparison, Excel is a relic of the last decade.