Business Budgeting – Why and What

Reasons & Methods for the Corporate Budget Process

Oct 28, 2008
Johanus Haidner

Budgeting is done for a variety of reasons. Many companies will use this to set benchmarks for managers and for bonuses, but this should not be the primary purpose.

Budgets are done in order to understand the direction in which a business is going, viewing future possibilities in growth, expected costs, and in order to plan for future events, including staffing, marketing, and more.

Prior Year Comparisons – Budget to Actuals

When examining a budget in comparison to prior years there are certain things that must be carefully scrutinized. These include:

Comparing changes in revenue and direct costs – these should be expressed in a percentage of the prior year’s figures. This allows one to see growth (or shrinkage) in the budget area.
- If there are drastic changes in one of these, then the underlying reasons need to be examined carefully, as these can indicate a number of things, including changes in the industry, an error in estimates, major 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, then this needs to be examined carefully.
  - Some managers will inflate costs because bonuses or other remuneration is based on the net (or gross) income figures that they achieve in comparison to their budgets. While not everyone does this, it is a solid motivator to decrease the Gross Margin and/or Net Income in a budget so that the higher actual margins are easier to achieve and thus reward the manager.
  - Such changes can be legitimate, as well, and one should not assume that it is otherwise. These need to be looked at in terms of what the market for the supplies, be they labour, 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 are indications that a market is maturing or has matured; they can also be indications of other market forces (high labour costs due to demand in a similar market taking your supply away or driving prices up), as well as indications of a change in the overall economy.
Changes in operating (indirect) expenses should be examined as well. For example, if there are suddenly high increases in office expenses, with no change in staffing, then one might examine why this is occurring. Is there a shortage of specific supplies? Have costs of printing, paper, or another frequently used commodity gone up significantly?
Changes in labour often account for the lion’s share of budgets. These need to be carefully scrutinized in every aspect. In theory costs of burden should increase by the same percentage as the costs of labour. 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 differences in the numbers.

That is a quick, general overview of why budgets are done. In order to complete a budget properly there are several factors that a manager needs to do.

Next... The Budgeting Process - Other Items and Issues