Budgeting Controls (#76)
/In this podcast episode, we describe a number of controls that can be applied to the formulation of a budget. Key points made are noted below.
Budgeting Problems
The annual budgeting process frequently involves multiple spreadsheets, many iterations, and more than one person handling the spreadsheets – and all of that spells trouble. It’s very easy for errors to creep into the budget, so you need multiple controls to keep them out. This also applies to implementing the budget, where errors can arise all over again.
Budgeting Controls
Let’s start with budget creation. Revenue drives everything else in the budget, so it helps to do some review work here. First of all, verify the impact of revenue assumptions on the company’s bottlenecks. For example, if the new revenue assumption is for a 20% increase, but there aren’t enough salespeople to find the extra sales, then you have a whopping big error right at the start of the budget.
Next, review the budget for step costing change points. These are large incremental expenditures that you have to make when volume increases past a certain point. So if a machining center can only handle 1,000 units of production, after which you have to spend $1 million for a new one, management might want to budget a little south of 1,000 units.
Also, try to simplify the model, which tends to keep errors out. This can be an annual budget simplification project, where you review last year’s budget, line by line, to see if any line items or formulas can be eliminated. In some cases, it can mean merging a couple of subsidiaries together for budgeting purposes, which can eliminate whole blocks of the budget.
You can also simplify by budgeting for entire groups of employees, rather than itemizing every employee on a separate line. So, for example, if you have 100 consultants on staff, put them all on one budget line, using their average rate of pay.
Another simplification trick is to merge small-dollar line items together. For example, you may have separate line items for telephones, office supplies, and building maintenance. You could merge them all together into a single account for office expenses.
Errors can also creep into the budget when company managers create their budgets each year. These people do budgeting just once a year, they don’t like to do it, and so they aren’t very good at it. This means they’ll very likely enter incorrect budget numbers that have no basis in reality. You can help them out with budget preloading. This means that you fill in most of the budget for them in advance for some line items, such as rent expense, telephones, and even payroll. They can always change these numbers, but in many cases their parts of the business aren’t going to change enough from year to year to call for much alteration in their budgets. So… the accounting department fills in the blanks for the easier line items; and company managers only have to deal with a small number of more volatile items.
Here’s one that very few people bother with, which is to manually recalculate the budget. For example, you may have a bad error in a summarization calculation, which makes revenues or expenses look too high or low. These are amazingly hard to find. If you’re going to do this, have a third party do the recalculating; they’re not emotionally tied to the budget, so they don’t think it’s perfect already – like you do.
After the budget is completely assembled, you may think that you’re done – but there may still be a problem, which is that some parts of the budget went through multiple iterations, but others did not. This means that one manager might have submitted a budget based on early numbers elsewhere in the budget that have since been superseded. So, the budget as a whole may no longer hang together very well. Unfortunately, this means passing out the budget one last time for another review by everybody. There’ll definitely be another round of changes, but it’s better to catch them now, instead of sometime in the next fiscal year.
Another step is to sign off on the budget. This means that you put the words FINAL VERSION in the footer line of every page of the budget, as well as the date and time. If someone has a copy of the budget without this verbiage, then they should throw it out. Also, the CFO should initial his copy and keep it in a safe place.
And then you have to load the budget into the accounting system. This is a great place to screw up. You might load in the wrong version, or mix up debits and credits, or just enter the wrong numbers. So, once the budget is entered, verify it for every month of the budget year.
Once that budget is loaded, lock down access to the budget module in the accounting software. Otherwise, a company manager might be tempted to enter the system and reduce his budget targets to make his results look better. Yes, this means not only requiring a password, but if possible, also using a log to track any changes made to the database. If you want to be doubly sure about this, consider doing a quarterly review of the loaded budget, just to make sure that it still matches the approved budget.
At this point, we have a hopefully correct budget, and one that’s been accurately loaded into the accounting system. Next, we should use it – after all, the budget itself is a control over how the company as a whole is operated. I covered most of this in episode 71, so this is just a refresher.
First, incorporate the budget into a feedback loop. This means creating a series of reports at the end of each month that’re designed to match the responsibilities of each employee. For example, you can have a report that shows just a single revenue line item that’s reported to a single salesperson for a single territory; that’s the only part of the budget for which that person has responsibility, so that’s all he should see. Yes, this means you may be issuing a boatload of reports, but it means that people will pay attention to the budget.
Also, use the budget for performance appraisals. This is common enough for salespeople, who may earn commission overrides if they make their budgeted revenue numbers. But also reward managers for making their department expense targets.
Parting Thoughts
In summary, budgeting is not like other accounting transactions, where you do thousands of them every year, and the emphasis is on efficiency. For the budget, it’s a very complex transaction that only happens once a year. Because there’s only one transaction, the emphasis should be less on efficiency and more on getting the output correct, and that means you need controls.