Reasons & Methods for the Corporate Budget Process
Budgeting is done for a variety of reasons. Many companies will use this to set benchmarks for managers and bonuses, but this should not be the primary purpose.
Budgets are done to understand the direction in which a business is going, view future possibilities in growth, expected costs, and plan for future events, including staffing, marketing, and more.
Prior Year Comparisons – Budget to Actuals
When examining a budget in comparison to prior years, certain things must be carefully scrutinized. These include:
- Comparing changes in revenue and direct costs should be expressed in a percentage of the prior year’s figures. It allows one to see growth (or shrinkage) in the budget area.
- Suppose there are drastic changes in one of these. In that case, the underlying reasons need to be sifted through. These can indicate many things, including changes in the industry, an error in estimates, significant changes in the market, and more.
- If there are significant differences in the percentage change between the two, such as a 4% rise in income, but a 14% rise in costs, this needs to be sifted through.
- Some managers will inflate costs because bonuses or other remuneration are based on the net (or gross) income figures they achieve compared to their budgets. While not everyone makes this, it is a definite motivator to decrease the Gross Margin and/or Net Income in an account. The higher actual margins are more comfortable to achieve and thus reward the manager.
- Such changes can be legitimate, as well, and one should not assume that it is otherwise. These have to be looked at in terms of what the market for the supplies, be they labor, materials, or products, is expected to do in that period. As well, there might be downward pressure on your sales prices due to competition or other market factors. Sometimes, these indicate that a market is maturing or has matured; they can also indicate other market forces
- (high labor costs due to demand in a similar market taking your supply away or driving prices up) and indications of a change in the overall economy.
- Changes in managing (indirect) costs should be examined, as well. For example, if there are suddenly high office expenses, one might look at why this is occurring with no difference in staffing. Is there a shortage of specific supplies? Have costs of printing, paper, or another frequently used commodity gone up significantly?
- Changes in labor often account for the lion’s share of budgets—these need to be carefully scrutinized in every aspect. In theory, the costs of the burden should increase by the same percentage as labor costs. However, there may be reasons for a change in this, such as a new benefits package being obtained, more staff enrolling or opting out, and even a calculation error that someone missed can show significant numbers.
That is a quick, general overview of why budgets are done. To complete an account appropriately, there are several factors that a manager needs to do.