Budgeting

The Top Five Most Common Budgeting Mistakes

Budgeting has been described as a cornerstone of an organization's financial management foundation. The budget serves as a benchmark against which financial results are measured, and variances from budget can be used to guide management's decision making.

There are a number of common mistakes made by organizations which can reduce the effectiveness of budgeting, and which may prevent the organization from achieving the maximum benefits from this valuable management tool. The most common budgeting mistakes are:

1. Budget is not contained in the accounting system, but is maintained in an Excel spreadsheet. This creates a number of problems, including the difficulty of keeping the budget accounts properly aligned with accounts in the accounting system, the time and effort needed to export data from the accounting system into Excel every month, and to format the variance reports, and the high potential for error due to the manual work involved.
2. Budget is not properly seasonalized. Monthly budgets are often created by dividing the annual budget by twelve, rather than taking into account normal seasonal fluctuations when establishing monthly budgets. This often results in variance explanations that are not very meaningful, such as "variance due to timing".
3. Significant variances from budget are not clearly identified. Most variances may be relatively small and not worthy of management's attention, and these may obscure the more important variances. Variances that are material, for example those that differ more than a certain percentage and/or dollar amount from budget, should be highlighted to bring them to the reader's attention. The level of variance materiality may differ from one organization to another, and should be set appropriately. It is helpful to use both a percent and a fixed dollar threshold in determining the materiality threshold. For example, all variances that are over 10% and over $1000 might be deemed to be material.
4. Variance explanations do not properly identify underlying cause of variance. For example, rather than say that "salaries are higher than budget due to a higher number of employees than planned", it might be more meaningful to explain that "salaries are higher than budget due to hiring additional employees to meet greater than expected demand for services".
5. Budget process is not clearly defined. There should be a financial policy that specifies who is responsible for developing the budget, who is responsible for approving it, and the timeline for this to occur. The budget should be developed, approved and entered into the accounting system before the beginning of the fiscal year.

By avoiding these common mistakes, your organization should achieve greater value from budgets, and ultimately this will enable your management team to make better and more informed decisions.