What to focus on and in what sequence…
Traditional annual budgets almost always result in a corporate budgeted income statement (P&L) that is constructed from all business entities that supply revenue and expense items. You can look at each entity in isolation, roll up to the next level, apply different versions of the budget and so on. Invariably, the end result is only one piece in the puzzle since there is no practical way to do a reliable forecast of the financial position of the company (i.e., the financial health along the budget timeline).
To make the process complete and useful to management, you must use the forecasted P&L, for every period of the budget and try to create a forecasted balance sheet, using the forecasted P&L and known beginning account balances, and many assumptions. Doing it correctly and accurately, using a spreadsheet, is not possible and those who tried (myself included) realized after a while what a futile exercise it was.
What follows is that very few companies properly forecast their balance sheets. Those who do, using a typical FP&A (Finance, Planning and Analysis) software application, usually end up using very broad assumptions, which coupled with the software’s inability to synchronize the balance sheet to the income statement (and its underlying budget) result in grossly estimated results that should not be relied on.
It takes a specific type of software architecture to be able to truly synchronize all financial statements to one another. The only way one can synchronize all forecasted financial statements is by making journal entries, representing all budget record activities in all budget periods and in all the business entities participating in the budget.
First priority: Choose FP&A software that uses the budget to automatically make all the required journal entries.
Choose a software that is designed using a unique architecture, that automatically executes all needed transactions (journal entries), which is why synchronized financial statements are possible.
This means that for all budget activities you enter in the system – whether they are derived from only one entity with only one set of revenue and expense items, or multiple entities using multiple dimensions each (e.g., Sales Territories, Product Lines, Customer Classes, etc.) – your budgeted (forecasted) financial statements will automatically be updated and synchronized to one another, just like your actual financial statements. Furthermore, the format and look of the forecasted financial statements can be made to look identical to your actual financial statements.
With such a solution, you’ll be able to easily see both sets of financial statements, side by side and in any imaginable arrangement and format. The best part is that these financial statements and all other reports provide direct line of sight for management to see, understand and make informed decisions.
Set priorities in the budget process and enforce them
The main goal in producing a corporate budget is to arrive at an agreed upon set of financial goals for the company and convey them in an acceptable format of forecasted financial statements and other operational reports.
The most important forecasted financial statement should be the Balance Sheet with its companion Statement of Cash Flows. Of course, you can’t get a balance sheet unless you have both balance sheet beginning account balances and an income statement where its account activities affect the forecasted balance sheet.
The focus, however, should be on the balance sheet, since it clearly conveys the financial position (aka the financial health) of the organization. By using an automated FP&A solution when creating the budget from revenue, operating expenses, personnel expenses, fixed assets and other transactional data, the system goes to work and behind the scenes creates all the needed forecasted financial statements, perfectly synchronized to one another, as if they came out of the actual accounting software’s general ledger.
The priority is to create a reasonable budget and achieve consensus on the feasibility of delivering results according to the budget. The software, in turn, will take care of all the accounting rules and calculations and deliver financial statements forecasting the financial health of the company according to the underlying budget. Relying on the software to do all the heavy lifting and perfectly keep track of the data will free you up to plan, analyze, report and reforecast.
Using this approach, company management and other stakeholders will be afforded reliable information that can be used immediately to make necessary decisions.
Alan Hart, MBA, is Principal Consultant at Pacific Shine Group in Portland, Oregon, with responsibility for client business development and hands-on client project implementations. Prior to starting Pacific Shine Group, he worked in various executive accounting and finance positions with technology and growth companies. Notable is his 18 years in the hi-tech manufacturing industry where he served as Controller, Vice President of Finance and CFO of several privately as well as publicly held companies in the Hi-Tech industry, such as Hybrid Arts, Inc., Hamilton Bay Associates and Syncronys Software. In his role in management consulting, Alan has worked in diverse industries and with a variety of clients, including fortune 1000 companies such as Boeing, Delta Airlines, Intel, Wyndham Worldwide and others, as well as many mid-market organizations such as Guitar Center, Ducommun AeroStructures, Cypress Semiconductor, TriQuint Semiconductor and others.
Combining his skills and experience in engineering with deep understanding of technical accounting, he is able to assist small and medium-size manufacturing companies establish GAAP compliant accounting and reporting systems.