Whether you’re starting from scratch or have a budget that needs to be updated for 2021, the start of Q4 is the perfect opportunity for companies that operate on a calendar year to begin the annual budgeting process. You’ll have a full three quarters’ worth of actual financials to base your budget on. And with the average business budget taking between two weeks and two months to create and get approved, getting started at the beginning of Q4 will help ensure a new budget is in place before the new year.
Many small businesses, particularly those with founders running the day-to-day operations, skip this important annual exercise. And that’s short-sighted, says Josh Farber, XMI’s chief financial officer. “If you have a budget, that means you also must have a strategy and plan to help you stick to that budget,” he says. “Without those things in place, it can feel more like luck when you get to the end of the year and assess how your business did. A budget forces you to have discipline and put your commitments down on paper.”
What’s more, he says, companies that create a budget tend to stick to it. Likewise, companies that have adopted and bought into accounting best practices and financial reporting are more apt to following a budget.
“Creating and following a budget makes good financial sense,” adds Brad Shaver, director of accounting for XMI. “We always enjoy working with clients on developing their annual budgets since it allows us the opportunity to work towards starting the next fiscal year strongly.”
We caught up with our resident accounting experts recently to find out what the annual budgeting process should look like—and how to avoid traps that can cause needless delays. Here’s what they had to say.
Step 1: Set your budgeting timeline
The first step in properly completing an annual budget is setting the timeline, which should be based on organizational capabilities, constraints and the complexity of your budgeting process. Remember that two weeks to two months range we mentioned earlier? Two weeks is par for the course for a small company with few departments. The larger the company, the longer it can take for the budgeting process.
When developing your timeline, Shaver says it’s important to consider not only the time it will take to assemble and prepare the budget, but also the steps necessary to gain approval. Depending on your company’s structure, final approval can range from senior level reviews within the organization, owner or key stakeholder review, or final review and approval by a board of directors. “Boards typically meet in late Q4 before the holidays,” he says. “By working backwards, companies can implement the proper check points and milestones to ensure the proposed budget is ready by that targeted completion date.”
Step 2: Decide on the details
The next step in the process is deciding on the proper level of detail that your budget will reflect. Will your budget include a high degree of detail, organized by account, location, division and/or department? Or, will a high-level budget, organized by line items on your profit and loss statement, be better?
You may be tempted to think that a high degree of detail is always better, but Farber cautions businesses to assess the cost benefit: “Is the juice worth the squeeze? Are you going to be able to empower people to make the business better by showing them this level of detail or is it just an exercise you’re going through?”
Farber says the best practice is to align your budget with your current—or desired—financial reporting structure. “If you’re tracking expenses in one lump, it probably doesn’t make sense to budget on a departmental basis,” he says. “But if you’re tracking on a departmental basis, your budget should mimic that structure.”
Step 3: Develop projections and document assumptions
To avoid delays farther along in the budgeting process, involve senior leadership in this important step. “Equip these leaders with year-to-date actuals and a full-year forecast if available so they’ll have a better feel for the starting point,” Shaver says. He recommends providing contributors with an easy-to-use, uniform spreadsheet where they can plug in requested information and it will be displayed in the right format for the final budget.
Once the data’s compiled, the next step is reviewing and analyzing the budget for accuracy and reasonableness. Compare to and reflect on the prior year’s budget, the current year’s forecast, and company specific metrics to ensure that the new budget is achievable, sustainable and works with the overall financial position and goals of the organization. This exercise is particularly useful during an economic downturn.
“Budgeting by its very nature is educated guesswork,” Farber says. “The key in any year, but especially now, is to document your assumptions and write down your thought process. It helps provide the why behind the what. It helps create visibility, enhances credibility and increases your change of getting budget approval without a ton of pushback.”
The benefits of documenting assumptions extend even beyond the budgeting process. “When you get into next year, you have another data point to help explain what happened,” he says.
Step 4: Present your budget for final approval
Showtime. Whether you’re presenting to a few key stakeholders or an entire board of directors, prepare for this meeting by having those assumptions documented (see Step 3) and talking points ready for any outliers or unusual items. Pull in department heads, or at least have them standing by and ready to jump in, if needed.
Once approved, don’t forget to share the budget with the rest of the organization, taking the time to provide high-level commentary on how it was created and offering to go into more detail, if requested. This level of transparency and insight goes a long way in establishing loyalty and buy-in to the plan.