Build effective budget models

Johan Smith

We often see budgets that try to predict the future in great detail without focussing on the fundamentals of the business, and without clear goals and actions as an outcome. Often that leads to mere future-telling without hands on the steering wheel.

What is an effective budget model? We assisted hundreds of customers over many years, and we learned the advantages of going through the following steps:

Review your strategy

Every business, no matter the size, should know why it exists and what it wants to accomplish. A strategy describes HOW you plan to achieve that.

Whether or not you have a formal written strategic plan or not, it is worth revisiting your strategy every year and updating your long-term objectives. No market or business is every static, things change all the time, and there could be new opportunities, markets, or threats for your business.

Determine your business goals

With your updated strategy in mind, what are your goals for the next year? Which actions should you take, how will they be funded, and what are the expected results? These are critical factors that need to be incorporated in your next budget.

Identify what drives your revenue

Every business has underlying mechanisms in its revenue. Product quantities, hours, kilos, or liters, what are the products or services that your revenue depends on? How is the pricing and costing expected to develop next year? Make sure you build this into your model so that your budget provides insight into all assumptions, actions, and expectations.

When you budget revenue on a volume-price basis, you will gain so much more insight (and clear actions) compared to simply applying x% on top of last years' revenue. Also, your variance reporting next year will be far more meaningful if you can see the underlying reasons of variances.

Understand your costs

Analyze your cost lines, and determine to which extend they are variable to revenue or fixed, and how you can influence the behaviour of each of these cost lines. Similar to revenue, certain cost lines may also have a volume-price mechanism, and you should build that into your model. The more underlying mechanisms you identify, the more actions and assumptions you can incorporate into your budget.

Plan your capital expenditure

Capital expenditure deals with acquiring or disposing of assets for your business, in the pursuit of achieving your strategy and business goals. Determine the actionable items for the next budget period, and how to best fund them (e.g. self-financed, leveraged, leased).

Clean up your Chart of Accounts

When all above is done, make sure your accounting will adequately reflect your business. Not the business it was years ago, but next year's business. Get rid of obsolete accounts, make sure your accounts have a clearly defined purpose and properly reflect key business activities.

We wrote another blog article about optimizing your chart of accounts.

Delegate and empower

The best budgets are carried by the entire organisation, and not dictated top-down. Accountability, ownership, and mandate go hand-in-hand. Analyze your organisation and determine how the budget can be divided into smaller parts. For example, can each location or each department budget their own activites? Can you break up revenue into regions, sales teams, or product groups? People will feel far more ownership if they have been part of the process. With a good tool such as XLReporting, managing the process and consolidation of multiple budget submissions is easy.

Put it all together

Build a model that clearly outlines all underlying mechanisms and assumptions. XLReporting enables you to create separate budget models for each part of your budget. For example, your sales teams can work in a model that exclusively deals with their part of the business, whilst the marketing team has its own model. The HR team has its own model too, so it can plan staff resources across the entire organization. A modular approach, which makes the process much easier for everyone involved. XLReporting will take care of the workflow and the consolidation.

Project your cashflow

When you build the models for revenue and costs, keep in mind that you want to be able to project cashflow, as this is one of the most vital factors in every business. Make sure your budget models have enough granularity so that you can derive a clear distinction between cash and non-cash outcomes.

Conclusion

Start with your strategy, work through your goals, identify your business drivers, delegate and empower, and make the process modular. Rather than struggle with spreadsheets, use XLReporting to manage the entire process for you. Workflow, data-entry, review, and consolidation, all can be done in one central system.