This is Part Three of our series on Budgeting best practices.
Last week, we explored best practices in budgeting for budget season. This included – messaging, project management, and relationships/partnering. This week, we explore more best practices and how the BudgetFYI module is a perfectly designed solution to ensure that your organization is following world class best practices when it comes to budgeting for the enterprise.
Scenarios. Absolutely needed in the modern world. While the board will approve one budget, they will be deeply interested in risk and variables. Having a tool that can easily and quickly create scenarios off of a baseline is crucial. Without the right tool, scenario planning in Excel is slow and manual. A best practice, at a minimum, is a best case, worst case, and most probable scenarios. Knowing upper and lower bounds, and the key variables helps an organization to react accordingly.
Each scenario should articulate clear and material drivers that may cause the organization to deviate from a baseline. For instance, if a key customer is alluding to ending their sales contract next year, and they were 20% of total revenue, a scenario where they drop should be seriously considered, along with the variable costs that would disappear. Alternately, if an organization is looking at an acquisition, that path should also be a scenario to understand net upside.
Use scenarios with intention and transparency. An optimal number for a mature organization would be 3-5 scenarios, while a startup or organization in a highly volatile industry may have 5-8 scenarios. All will have variations clearly articulated in the notes section to help the user understand what is different, and the amount of risk and probability behind the scenario.
Fixed costs vs variable costs. Along the lines of scenarios, another best practice is being able to identify fixed, variable and semi variable costs. Fixed costs will remain constant and predictable for a period of time, irrespective of the level of production or output. Some are perfectly fixed (rent, lease payments, fixed salaries, insurance), others may lower over time in a predicable trajectory (interest payments), while others may be somewhat predictable, but may have slight variation (utilities, fixed benefits).
Pure variable costs are typically raw materials, production labor, and packaging related to production. Variable costs are calculated by applying the quantity of output by the variable cost per unit of output. Costs can become semi-variable where they are fixed up to a certain production output but may materially change upon a new level of activity. In mentioning utilities, while power expense will likely always exist at a minimum amount, doubling production by working multiple shifts can cause this expense to become semi-variable.
Finally, in the long run, all costs are variable. While rent is fixed in the short run, the decision to not renew a lease, or enter into new leases can cause this to change.
R&O matrices. As discussed in an earlier article, Risk and Opportunity matrix usage is a best practice, especially as an organization goes throughout their fiscal year. New risks and opportunities will manifest constantly. Some will disappear as quickly as they pop up, others will become actual events. Having a central repository and tool to monitor these is key. Applying probability and pre-tax impact will help keep visibility even into the next budget year, as many items will straddle into future years.
Other best practices. Utilization of analytics and dashboards to measure key financial metrics that would come out of a budget scenario is important. For instance, measuring profitability measures such as ROI, EBIT, and certain margins helps determine overall organization impact before bringing a budget to the board. In fact, boards will be deeply interested in key metrics that accompany submitted budgets. That data will be part of the presentation.
Having an enterprise analytics dashboard that measures profitability, CAGR, and growth rates dynamically acts as a barometer for the accretion and health of the budget as it is rolled up. Boards want to know that the organization has put thought and preparation into their submitted budgets and are well prepared to defend the numbers (built with best practices).
In addition to analytics and dashboards, another best practice would be to use an enterprise budgeting software suite that can not only do the day to day tasks associated with budgeting and forecasting, but also one in which can do the heavy lifting. As well, a suite of finance and analytics software tools that can scale and grow with the company is ideal.
In closing, remember this- Developing an accurate budget is a critical component of financial success; that being said, always know that a budget is a living, breathing organism that should change according to the needs of the business. Know that a major element of financial data activity rests in the act of budgeting. Thus, the process of allocating finite resources to the prioritized needs of an organization is tantamount to survival. As such, the budget process will always be a product of the planning process.