A step-by-step budget preparation process

In this article I will take you through a step-by-step process of preparing your budget. You are coming to the financial year end and you therefore need to start preparing your budget if you have not already done so. It’s critical that your organisation has a budget so that it can help you in planning, coordinating your company’s activities, tracking performance and also in motivating your staff since they will have a target to work to. Without a target, your team will be groping in the dark as to what they would like to achieve.
The following steps discussed below are indicative of what many organisations follow although there could be some slight differences but the main the principles are the same.

The first step that should be done is to ensure that managers have the strategic plan or long term plan. The strategic plan will give direction as to what the organisation would like to achieve over a long period.
The strategic plan gives guidelines to the managers who will be preparing the budget. They will have the broad targets that need to be achieved. It’s very critical that before starting the budgeting process you communicate the details of the strategic plan to the managers who will be involved in budgeting. You should then also communicate the budget guidelines to the managers.

These will refer to economic indicators that the managers should take cognisance of during budgeting. These factors would be forecasts of inflation rate, interest rate, wage rate increases, changes in productivity and information about industry demand and output. These will help when preparing the budget.
The next step will be the determination of the limiting budget factor or the principal budget factor. The limiting budget factor is a factor which places a limit on the activities of an organisation. In most organisations the principal budget factor is the sales demand: in such a situation the company will be restricted from making and selling more of its products because there would be limited sales demand for the output at a price which would be acceptable or profitable to the company.

In some situations, the principal budget factor may be lack of adequate machine capacity or the limited availability of key raw materials or the availability of cash. You therefore need to establish exactly what the limiting factor is for your company. Once this factor is defined, the rest of the budget can be prepared based on this limiting factor.
For instance, if sales are the principal budget factor the production department can only prepare their budget after the sales budget is complete because quantities to be produced will be dependent on sales quantity. Each organisation needs to determine exactly what will limit its operations.
If sales demand has been determined as the limiting budget factor then the sales department will prepare their budget before other departments whose budget is dependent on sales. The sales team will prepare the sales volume expected to be achieved in the coming year.

In arriving at sales forecast the following factors have to be taken into consideration: prior years’ sales patterns, the economic environment, pricing policies, competition, and legislation, changing consumer tastes and results of market research if you have done one. There are a number of methods that you can use in forecasting the sales figures. You can use the results of a market research, or sales personnel can estimate from their customers demand, or you can check requirements by customers from annual contracts if there are contracts with customers. You could also use some statistical methods of forecasting.

Based on these sales figures, production can start preparing their production budget. The production department will have to look at finished goods stocks and then decide on closing stock levels required and then determine the quantity to be produced. The production budget will be in units at this stage.
After preparing the production budget, you can determine the machine capacity or machine utilisation required and the inputs into production which will be the raw materials, labour and any other consumables.

The materials usage budget will be based on each type of material required by units and then by costs. An element of normal loss likely to be incurred in production through breakage, or wastage should be built into budget. The machine utilisation budget will show the operating hours required for each machine. This will help the number of machines to be deployed in production and the figures will also be used by maintenance department in preparing their budget.
The labour budget prepared by production will be expressed in hours for each grade of labour and then converted to cost in consultation with human resources department.

The labour hours should build in an element of idle time due to machine breakdowns or other factors that might affect smooth production.
Once these budgets have been prepared the finance team can now prepare the selling, administration and distribution expenses budgets. When preparing each of these budgets the expenses should be based on the drivers of the costs. For instance if it is fuel costs you are budgeting you should base the expense on the number of trips to be made, fuel usage per litre and the price of fuel. By basing the budgeted expenses on the cost drivers it will be easy to then control that cost because you will have to control the cost drivers like trips or the price of fuel by choosing the cheaper supplier.

Once managers have prepared their draft budgets they should submit to their superiors for approval. The manager will negotiate with his superior for the initial approval of the budget. Each of the departmental budgets will consist of the revenue and expenditure budget and the capital expenditure budget.
All departmental budgets are then sent to the finance department after being approved by department heads. The finance will consolidate all budgets into one master budget for the company. The master budget will be comprised of the income statement, the cash flow and the balance sheet.

The master budget is presented to the budget committee for approval. The committee will ensure there is consistency with the long term plan since the budget should be derived from the strategic plan.  After approval of the budget by the budget committee the budgeting process does not stop there. Actual results should be compared on a regular basis with the budgeted figures.  It is vital that the budgeting process follows the correct order based on the principal budget factor and that the overall process should be co-ordinated to ensure that the budgets are all in balance with each other.
Enjoy your budgeting.

l Stewart Jakarasi is a business and financial strategist and a lecturer in business strategy, advanced performance management and entrepreneurship. For assistance in implementing some of the concepts discussed in these articles please contact him on the following contacts: sjakarasi@gmail.com, call on +266 58881062 or WhatsApp +266 62110062. Website shekinaconsult.com.