Marketing and Business Strategy

Step 7. Explanation. Budget explanations create a lot of trouble for everyone. That’s because in most cases, there is no logical assump¬tion base. So what can you say about an expense that’s higher than the budget?
In the traditional system, you might make an explanation sound good, without really saying anything at all. For example, “Actual expenses were 12 percent above last year’s level. We estimated a 5 percent increase.” This explanation says nothing at all about the cause of the variance; it only admits that the budget was too low, a fact that everyone already knows.
Unfortunately, this type of non explanation is so common that it’s acceptable. We find ourselves coming up with new and novel ways of saying nothing, so that the corporate belief in budget review is satisfied. A real explanation, in comparison, is based on an analysis between the components of actual spending (or income), and the components of the assumption base. With this method, precise reasons for a variance are quickly and easily identified. From there, it’s a relatively easy step to take action, because a cause is now understood.
A variance exists for only one of four reasons: (1) The budget did not anticipate something that happened. (2) The timing of the budget was in error, and will be offset in the future. (3) Internal accounting created the variance. This may include a coding error, an accrual, or an allocation not included in the budget. (4) The variance was predictable, but the original budget was changed arbitrarily from above or by the accounting department-in spite of well-docu¬mented assumptions.

Step 8. Investigation. In some cases, the explanation cannot be filled in by the budget review meeting, because the person or depart¬ment preparing the review (usually accounting) does not know the answer. At that point, an investigation is in order. It might be possible to assign the problem to one department, or it might be necessary to ask each manager to look into individual budget assumptions to identify the components of the variance.
Investigation is troublesome on a companywide basis. No one will want to take responsibility for explaining the variance, or for looking into it. As an unfortunate consequence, the accounting department ends up with the lion’s share of budget-reporting duty. This means that, with or without your knowledge, your department could be criticized for a budgeting problem, even if you had nothing to do with developing that budget.

Step 9. Response. Once investigation is complete, some form of response is demanded. If an expense is running above a reasonable budget level, it should be brought under control. If the problem is strictly in one department, assignment of response is simple. How¬ever, it is more often a companywide problem and, again, no one will want to tackle the problem. So the accounting department again is given the responsibility and the power to respond and to solve. The power issue wouldn’t be a problem in itself, except for the fact that you should want to control and answer for your own budget.

Step 10. Review. Once a problem is discovered and the process of correction is entered into, the review process begins. This is a year-¬round, never-ending, ongoing effort, one that should be instituted as a daily priority and as part of your routine. The idea of monitoring the budget is too often delegated, or thought of as an unpleasant and inconvenient demand on our time. Think of the control and review process not as manipulation of rows and columns of numbers, but as real and tangible events and financial consequences-that you can and should control as part of your job.

Step 4. Sales forecast. The sales forecast should precede the cost and expense budget. Because your business and marketing plan is based on assumptions concerning an expanding market, the sales number should be developed as a first step. In many companies, expenses and sales are budgeting separately, which makes no sense all. Sales forecasts should be broken down by market, by month, and, if necessary, by sales office or other “unit of production” in your marketing arm. This enables you to later identify causes of variances.

Step 5. Budget. The cost and expense budget is based on intelli¬gent assumptions related to the nature of the category. But in addi¬tion, the budgets will be directly affected by sales levels and timing. For example, if you believe that the summer months will experience a much higher than average sales volume, then it makes little sense to spread operating and variable expenses evenly throughout the year. You will then have timing differences in your budget. While these may not be major problems, they do cloud the important issues, often hiding real unfavorable variances from view.
Often overlooked in the budgeting process is the importance of cash-flow projections. Once you have completed a sales forecast and cost and expense budgets, you should next develop the year’s cash-¬flow projection, as part of the test to see whether the plan will work. What could go wrong? Cash flow will be affected by any number of situations. For example, what if you need to invest in capital assets? What if the new sales volume occurs on account, but related costs and expenses must be paid monthly? What if your inventory level has to be doubled in the first quarter? All these events will demand addi¬tional capital. You need to ensure that you know where that capital will come from.

Step 6. Monthly review. This is a process of comparing actual to budgeted outcomes. The review should involve sales forecasts, cost and expense budgets, and cash-flow projections. Without the monthly review, you are not going through the budgeting process at all. Instead, you’re letting the effort go to waste. Only by looking at the numbers can you tell whether the plan is working.
The review can be simplified to a great degree. This is most desirable. You don’t want to keep a room full of busy managers and executives sitting for hours while going through a large volume of detail. All you need is a report showing each category in three columns: actual, budgeted, and the variance. If the variance is minor, no action is required. But if the variance is unacceptable, proceed to the next step.

The budgeting process is not just filling out blank worksheets, with columns for every month and rows for each expense classifica¬tion. That’s only the beginning, the very first step in a more compre¬hensive operating system. In fact, the visible budget worksheet is only the first of three major steps in the complete budget.

The second step is the monthly review. The budget becomes worthwhile only when the managers of each department sit down together and review the budget in the light of what actually hap¬pened in all the revenue, cost, and expense categories. In this review, any variances are highlighted and explained.
The third step is the follow-up action that is taken when an unacceptable variance is discovered. This is the most critical step of all; it is where the real profits are maintained and created.

That is the budgeting process in overview. A more detailed, step¬ by-step explanation is given below:

Step 1. Plan. A properly prepared budget grows from a well¬ defined business and marketing plan. Without a plan, the organiza¬tion lacks direction. And without direction, the budget will be arbitrary.
The plan explains the current year’s marketing goals. The fore¬cast and budget are the financial expression of those goals, and they demonstrate that the goals are practical and can be achieved. The plan does not suggest that the numbers will fall exactly as shown, or even close. It does show that the plan is realistic and that it can be achieved. The numbers work.

Step 2. Goals. Setting goals as part of the plan is a logical and necessary step in the budgeting process. We should keep in mind that, in spite of the way things were done in the past, the worksheets, filled with numbers are only part of the whole. Those columns and rows should represent the financial expression-and realization-of clearly stated goals.

Step 3. Assumptions. The key to budgeting is developing intel¬ligent assumptions. For example, a sales forecast makes sense only when broken down by its component parts. So for example, if sales are generated by salespeople in the field, it makes sense to forecast based on assumptions about recruiting, attrition, and average pro¬duction. Expense budgets should be developed based on the components that logically constitute each category. The variable expense groups may vary with sales activity; overhead expenses are developed according to some logical pattern. Abandon the usual base for budgeting: percentage increases spread evenly throughout the year. These are useless to a need for analysis that will arise later in the year.
It also makes no sense to use the past, especially if the budget didn’t work. Ask yourself, if last year’s expenses exceeded budget, why are you using that outcome as the basis for the coming year? That’s building in excessive expenses rather than creating controls to reduce the spending level.