Budgetary planning is the process of constructing a budget and then utilizing it to control the operations of a business. The purpose of budgetary planning is to mitigate the risk that an organization's financial results will be worse than expected.
The first step in budgetary planning is to construct a budget. This is accomplished by engaging in the following tasks, which are presented in their approximate order:
- Obtain strategic direction from the board of directors. This step is needed to set the general direction of the plan, such as to add a new product line or to terminate a subsidiary.
- Create a calendar of budgetary milestones. Specific due dates are needed to ensure that the management team creates their respective portions of the budget on a timely basis, so that these pieces can be rolled into the main budget model.
- Create budgeting policies and procedures. This documentation is needed to give direction to those managers involved in the creation of the budget.
- Preload the budget. In some cases, it is more efficient to supply managers with a preliminary budget model that already contains an estimated budget. The estimated budget is based on historical results, adjusted for inflation. Managers can then focus their attention on the more critical changes to the budget model.
- Issue the preliminary budget model, with policies, procedures, and milestone dates, to the responsible managers. The person in charge of the budget then provides support to these managers as they adjust the supplied budget model.
- Aggregate and revise the model. As budget segments are returned by managers, the segments are aggregated into a master budget model, which is then reviewed by senior management. These managers will likely mandate changes to the model, such as adjustments in capital spending or expense levels. These mandates necessitate a series of revisions by those managers who create the model.
- Once all parties are satisfied with the budget model, the board of directors signs off on it and the accounting department loads it into the accounting software, resulting in budget versus actual financial statements.
Once a budget model has been completed, it is then used to control the operations of a business. This can be done in the following ways:
- Report budget versus actual variances to management, so that the largest negative variances are investigated.
- Pay bonuses based on compliance with the budget.
- Only authorize expenditures if there is funding left in the budget to do so.