Budgets are a beginning of year strategic plan stated in financial terms.
The budget process often starts with a review of previous performance within a strategic “what if” type framework. An example is the “du-Pont” or “EVA” methodologies which allow previous results to be rolled out into future periods. Then by goal seeking, a future desired Return on Capital Employed (ROCE), profitability, cash flow and increased value can be quantified. These measures become the strategic targets to be achieved via the budget process.
“Non financial” budgets link strategy to the management team planned activities so that they know what is required of them and how their performance will be measured.
Budgets can be as simple as a high level profit & loss, balance sheet and cash flow report to satisfy the banks over draft requirements or highly detailed for a capital raise. Budgets add value by increasing certainty to the organisations investors, lenders and managers by stating its intended direction and operational targets. Budgets become an important performance measure showing whether the organisation is on track to achieve the strategic plan.
Budgets prioritise goals and capital requirements detailing how working capital will be optimised to minimise funding for new capital expenditure, projects and growth whilst ensuring an adequate return on investment.