Martin Little is a CIMA qualified finance expert and avisso’s Finance & Budgeting Consultant. Here he provides some useful considerations for budgeting
The budgeting process is a key part of management control systems, giving managers the ability to plan, coordinate, control and measure performance. However, it can be viewed as a burden by some given the potential time and resource often required in the process.
With the growing uncertainty driven by Brexit and surrounding factors, and the increasing cost pressure on food and labour, it is a particularly tricky time to be planning and creating your next catering or housekeeping budget. Before your next year’s budget planning is complete, do have a read of these considerations and approaches that you may find helpful.
Budget Planning & Preparation
There is no ‘one size fits all’ solution when it comes to budgeting and every budget, be it the annual organisational budget or one for a specific project, will require unique considerations. There are some standard steps, however…
1. Incremental Budgeting
This is the traditional method for preparing a budget. Budgets for coming years/periods use the current budget or actual performance as a starting point, with incremental amounts being added to the new budget. These incremental adjustments allow for things like inflation, increased staffing, plans to increase outputs or volume and increases in sales prices/food costs.
The benefits of incremental budgeting are that they tend to be:
- Easy to prepare, therefore quick to produce with minimal labour allocation and cost
- Easy to understand
- Create less tension between various budget holders as the approach is consistent across all parts of the budget.
The drawbacks of incremental budgeting:
- They assume that all current levels of costs within a budget are needed
- Previous costs are not analysed and budget holders only need to justify the incremental increase rather than the entire cost
- They offer little incentive for budget holders to reduce costs or be creative or critical of previous spend. This approach could lead to a ‘use it or lose’ attitude leading to unnecessary spending through fear of losing resource for the next budget year/period
- Inefficiencies from previous budgets are simply carried forward and compounded by continual incremental increases. With no process to review previous performance, inefficiencies will go unnoticed.
2. Zero-Based Budgeting
As the name suggests, the zero-based budgeting process starts from zero. No reference is made to previous budgets, target budgets or actual results. All parts of the budget are built up from zero. This differs from incremental budgeting where previous budgets/performance are used as the starting point. Those responsible for the various parts of the budget are responsible for reviewing and justifying all expenditure in the budget, the theory being that all unjustifiable expenditure is removed.
The benefits of zero-based budgeting are:
- By not assuming previous budgets or actual performance is appropriate for the coming budgetary period, issues can be identified in existing budgets and inefficiencies and obsolete spend or allocation can be removed
- This approach creates a bottom-up approach to budgeting, encouraging participation of employees in the process and their motivation to own and actively manage their budget(s)
- It encourages a questioning attitude among employees
- Budgets respond to changes in the business environment, rather than assuming factors remain the same as the previous period.
There are also drawbacks to zero-based budgeting, as shown below:
- This process is time and resource-heavy. Large operations may not have the manpower to produce a timely budget by starting from scratch each period
- Thorough and complete justification of budget lines may not be possible – tracked results and ROI are not always possible to measure, for example
- Data required to analyse every budget line may not be available (see also the point above)
Both methods have strengths and weaknesses and using aspects from each method may be the best approach. In either instance, it is important to identify all the possible budget lines and to have some understanding of the factors that could affect these lines for the coming budgetary period.
Using the budget
Having planned and produced a budget, it is equally important to actively use it. It should be a live document, not simply filed after completion, and should be regularly reviewed against assumptions to ensure it remains relevant throughout the period.
After producing the main budget, it is useful to phase it. For example, for an annual budget it would make sense to break it down into monthly or quarterly elements based on known activity levels.
This will then form the basis for regularly reviewing performance against the budget.
Variance analysis is this process of comparing actual results against those expected in the budget, thus identifying any variances. It is important not to just identify a variance; action should then be taken to understand the reason or reasons it occurred and the impact it will have moving forward. No single variance should be looked at in isolation.
The diagram on the right uses a catering budget as a simple example of this…
An adverse variance in the cost of sales for the period, viewed simply in isolation, could lead to the assumption that a manager has overspent or is under pressure from unforeseen cost increases. However, when considered alongside the increase in sales, it would be expected that purchases are in fact over budget, due to higher than expected demand prompting extra spend to meet this demand.
Drawbacks of traditional budgeting and alternative approaches
Whilst widely used, the traditional budgeting process is not without its critics who may point out that traditional budgets:
- Are time consuming to produce and complicated to manage
- Can have too much reliance on historical data (incremental budgeting)
- Are inwardly focused, hindering a company’s ability to adapt to change and external factors
- Promote ‘use it or lose it’ attitude among managers and reduce ownership and motivation to think creatively period to period
- Tend to be based on assumptions, which could quickly make the budget irrelevant.
What does this mean? Conclusions.
Whilst elements of incremental and zero-based budgeting can be combined, there are alternative approaches that could be considered, too.
A projection/estimate of future performance based on past performance, updated frequently to reflect changing business conditions, giving better accuracy and saving the time required to build a budget from scratch.
A model born out of the idea that traditional budgets are holding back organisations and the abolition of the traditional process can improve management control by being the driving force behind a re-examination of how an organisation may be better managed.
Whatever approach you – and your organisation – take to catering and housekeeping budgets, the creation of the budget is just one element. The ongoing management and involvement of the budget holder and stakeholders in that budget is key.
This blog really just scratches the surface. If you are interested in more information or arranging consultancy or training for budgeting, please have a look at support available here: https://www.avisso.co.uk/services/budget-management/