Article

Operating Budgets, Preparing

 

 

FINANCIAL MANAGEMENT AND ACCOUNTING

Preparing Operating Budgets

 

A budget is a working document that predicts all income and expenditures for the organization for a specific period – usually at least one year. The budgeting process enables the organization to forecast its needs, both for the current year and long term. The following accounting documents should be prepared and kept current every year:

Annual operating budget for current fiscal year Contingency plan:  Steps to be taken if circumstances change Three-year forecast budget Long-range capital expenditures budget

The purpose of this article is to provide working guidance in the preparation of the annual operating budget for the organization.

 

Annual Operating Budget

 

The timing of budget preparation may be determined by the source(s) of funding for the organization. In any case, it is wise to begin budget preparation three or four months before the end of the fiscal year.

 

All key operational managers should be involved in the budgeting process. This affords senior management the benefit of working supervisory knowledge, and it promotes “buy-in” from first-line managers.

 

Goal setting. Before budgeting, the management team for the organization should develop plans for the coming year. This includes setting goals for the types and volumes of services to be provided to customers. Department heads may be asked to prepare brief presentations describing any proposed new or expanded services. Decisions need to be made about new or expanded services before the budgeting process begins. This requires setting priorities and ensuring that all managers are working toward common goals.

 

The budgeting process. Before beginning the process, the Accountant or Accounting Department should prepare a package of instructions and essential forms to guide managers in budget development. This package of instructions should be reviewed with budget participants at a meeting. This package may include:

Projected service volumes for the coming year Specific guidance on the total increase or decrease targeted in the budget Known price increases/decreases New activities or initiatives approved for the coming year Economic forecast for the budget period and predicted impact on operations Maximum allowable salary increase percentage for budget period Payroll worksheet (Productive, nonproductive hours by employee) Year-to-date actual performance plus remaining months budget estimate (e.g., 8+4, 9+3) spreadsheets Policies and procedures for capital equipment requests

Forecasting income. An income forecast should be prepared before the expense budget is done. Ideally, some process has been put in place to secure commitments for the coming fiscal year in advance of this budgeting process. This process may include surveying major contributors or supporters about their continued commitment. It includes estimating public support based on past experience, and estimating probable income based on event-based fundraising experience. If the organization offers fee-based services, the income from this should be estimated. The income projection needs to be as realistic and solid as possible because it dictates the scope of operations for the coming year. After the income budget is complete, it will be possible to assess the percentage of increase in expenses that is possible – or the percentage of required decrease if income is less.

 

Fixed expenses and overhead. Accounting may prepare in advance those accounts that represent overhead and fixed expenses:  rent, leases, depreciation, professional fees and insurance. They may estimate the operating expenses for buildings and grounds – utilities, telecommunications and maintenance.

 

Salary budgets. Every department should complete a worksheet that includes the hours to be worked by every individual on the payroll and the compensation rate per hour. This document should forecast productive (straight time and overtime) and nonproductive (nonworking – vacation, sick leave, etc.) hours. Accounting may choose to use these worksheets to create the salary budgets to accurately reflect the accrual process between pay periods. Or, Accounting may specify the process to use in calculating accurate monthly salary amounts.

 

Any compensation in addition to hourly income must be indicated:  shift differential, allowance for tools or uniforms, or bonuses.

 

Expense budgets.  After the income and salary budgets are constructed, the expense budget is compiled. The overall budget should not exceed anticipated income. If the income is not foreseeable at budget time, it should not be counted. It’s always easier to adjust spending upward to use unanticipated income than downward to compensate for the lack of income.

 

Managers should create line item budgets for each account, basing projected usage on recent history. The most common approach is use of the actual plus remaining budget projection to determine usage for the current year. This gives both a volume and cost estimate. The volume estimate can be adjusted to account for anticipated changes, and the cost estimate should be based on known or anticipated increases. Managers should be asked to explain two kinds of variances for each account:

Why does the amount for the new budget differ from last year’s budget?

Why does the amount for the new budget differ from the actual plus budget estimate?

 

If the budget represents a significant increase, the manager should provide a narrative explanation of anticipated changes in scope of operations, whether services or increased volume.

 

Budget Review.  After Accounting has compiled all budgets into budgeting software or computer spreadsheets, the organizational budget can be produced. At that point, the chief administrator and the chief accounting officer should review with each manager the proposed departmental budget to answer questions or to make necessary changes. After all the changes are made, the new budget may be discussed in a joint management meeting. This budget will be presented to the Board of Directors when complete.

 

Contingency Planning

 

Contingency planning is a proactive way to address possible losses of income or funding. It identifies potential levels of income loss (usually stated as a percentage of total income) and determines in advance the strategies that will be implemented to adjust to the new circumstance.

 

For example, assume that for the past four years a large charity has donated an amount equal to three percent of the organization’s total income. How would the organization deal with the unanticipated loss of this income? It cannot be assumed that income will be located to replace the loss. The assumption must be to adjust operational expenses downward to compensate for the loss. This is not always a dollar-for-dollar decrease, although that is more likely to be true in nonprofit organizations than commercial enterprises where cost is associated more directly with income.

 

The levels should be set by examining the sources of income. If the income is based on several sources of funding, and all are large, the potential shortfalls may be in large percentage increments. If the income is from broadly-based public contributions, the percentages may be smaller. In either case, three or four levels of income loss should be specified (2%, 4%, 6%, 8%, or 5%, 10%, 15%), and the dollar volume computed.

 

This amount becomes the target amount to remove from a contingency expense budget. It is seldom possible to ask for a uniform percentage of expense reduction across all departments. Some departments are nearly all fixed cost or overhead. All managers should be asked how they would respond to the need to reduce operating budgets. They should identify reductions, explain how it would be possible to make those reductions, and what the impact would be on services to users. Should the need for budget reduction occur, the plan would be available for immediate implementation.

 

 

 

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DISCLAIMER

This work is supported under a five-year cooperative agreement # H235V060016 awarded by the U.S. Department of Education, Office of Special Education and Rehabilitative Services, and is administered by the Pass It On Center of the Georgia Department of Labor – Tools for Life.  However, the contents of this publication do not necessarily represent the policy or opinions of the Department of Education, or the Georgia Department of Labor, and you should not assume endorsements of this document by the Federal government or the Georgia Department of Labor.

 

 

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Other Information

Title: Operating Budgets, Preparing
Module: Finance/Accounting
Author: Trish Redmon
Audience: Administrator
Sub Title:
Procedure: How to begin the budgeting process
Organization Source: Pass It on Center
Last Reviewed: 08-27-2009 7:35 AM