At some point in the life of your business, the budgeting and planning process will need to evolve from manual spreadsheet purgatory to an automated, transparent process that aligns with your business goals – that is if it hasn’t already. A company’s budget is THE planning tool upon which every part of an enterprise will build its operating plans and measure its success or failure. With the almost universal access to, and use of, Enterprise Performance Management (EPM) solutions for the tracking and reporting of actual financial results, it is only logical that you will leverage these tools to build your budgets and forecasts.
This post will overview how EPM solutions align with the budgeting and forecasting process. We’ll also present a look at the basics by outlining the “traditional” budget process itself.
“What do I have, what will I need and when will I need it?”
EPM: The Modern Approach to Planning and Budgeting
An EPM solution is used to track and report on the actual use of:
- Enterprise assets
- The state of your obligations
- Performance in the form of sales
- The cost of doing business
The right EPM solution will track your core assets, money and time, and the use of these assets, thus creating another asset for your organization—DATA. As you know, time and money are scarce resources to all individuals and organizations, so the efficient and effective use of these resources requires planning. As an Oracle Platinum Partner, we believe the Oracle EPM Cloud products (formerly known to many as Oracle Hyperion products) are some of the best tools to efficiently and effectively manage your assets.
Incorporate Your Budget into Your EPM
Most, if not all, EPM platforms such as Oracle Cloud include planning and budgeting capabilities – Oracle PBCS (formerly Hyperion Planning). If not explicitly called “Budget”, they generally allow for multiple “Scenarios” against which the enterprise’s results and projections can be compared. Theses scenarios can generally be called anything you like, as budgeting and forecasting is only one of many uses for this comparability. You could also look at these scenarios to measure the impact of mergers, acquisitions, divestitures, etc.
How are businesses conducting their budget cycles?
In a 2016 survey by Radius Global Research, it showed 57 percent of respondents were still relying on Excel for their budgeting—either standalone or with other systems. Alternately, 49 percent were using a dedicated EPM solution. About 80 percent of respondents reported at least five rounds to each budget effort, and that they did at least six budgets each year: an Annual Operations Plan (AOP), four re-forecasts of the AOP, and an extensive Capital Expenditure budget. For some organizations, they are ALWAYS budgeting, which could be a key indicator that their budget cycle isn’t operating as efficiently as it should be.
The Biggest Challenges in Planning and Budgeting
Entrenched budgeting and forecasting processes may be difficult to maintain and manage because revising them can be challenging both politically and pragmatically, i.e. what if they break? But constant change is inevitable, so consider moving your EPM platform to the cloud and think of it as an opportunity to challenge old methods against best practices.
Ensuring data integrity is a foundational challenge. Because of this, your EPM system is the optimal place to build the budgeting and forecasting process. Why? Because a single platform that has the security and data integrity to house your actual results is a finance best practice policy and process.
Enterprise communication is also a huge issue in any corporate endeavor. While Finance may own the process, each respective business stakeholder OWNS their budget. The sales organization owns the sales forecast and their respective administrative expense budget, IT owns their spending and capital budget, and HR, Operations, Facilities all own every operational and functional area of their budget. And these are just “standard” business stakeholders. Depending on your unique circumstances, you may have other business-critical stakeholders who feed into corporate performance equation.
As Finance owns the planning and budgeting process, it is very important that they work across departments to align goals – which often creates additional workloads. There is no doubt that every finance team is going to feel growth pains, both within their Finance organization and the business as a whole. And at some point, having a “single source of truth” means everyone is looking at the same numbers and making the best decisions based on those numbers.
Moving to cloud-based EPM greatly improves enterprise communication and continuous collaboration.
Best practices for improving the budgeting and forecasting process:
Below are just some of the recommendations we have for improving your planning and budgeting process:
- Reduce the number of cycles per process
- Keep “known” revenue and expenses constantly updated
- Design procedures that allocate resources strategically
- Continuously evaluate past performance
- Automate the drivers of revenue and expenses
- Drive accountability through accessibility
- Continuously refine frequency and level of detail
- Link budget to corporate strategy
- Tie incentives to performance measures other than meeting budget targets
- Link cost management efforts to budgeting
- Lock-in the single source of the truth and then perform “what-if” scenario modeling
- Reduce budget complexity and cycle time
- Develop budgets that accommodate change
It’s important to remember that automation and streamlining of budget processes are two very different things. Automation ensures tasks are accomplished faster whereas, streamlining ensures tasks are done smarter. By automating and streamlining financial reporting processes you give your team the ability to act as strategic partners to the business and not just pencil pushers.
Leveraging an EPM environment enables standard management of each core process that every company must do well, including budgeting, forecasting, consolidation of actual results and financial reporting, i.e. telling the story of what happened during a given time period. What’s more, an EPM solution leverages the investment you have already made in Enterprise Resource Planning (ERP), Customer Relationship Management (CRM), Supply Chain Management, Sales Force Automation, and other transactional systems. EPM allows you to gather inputs from these investments, as well as other corporate stakeholders, so that you can streamline and automate your budgeting and forecasting process.
Back to Basics: The Budget Process Itself
1. Projecting Balance Sheet Line Items
Cash is the starting point, and cash is on the balance sheet and is the lifeblood of any enterprise.
Projecting balance sheet line items is typically done in conjunction with projecting income statement line items. Both of these skills are necessary when mastering the art of budgeting. Our goal here will be to break down step-by-step how to calculate and then forecast each of the line items necessary to forecast a complete balance sheet and build a 3 statement financial model.
Balance Sheet Forecast items
The following are the main accounts we need to cover when projecting balance sheet line items:
- Accounts Receivables
- Other Current Assets
- Other Long-Term Assets
- Accounts Payables
- Long-term Debt
- Shareholder Capital
- Retained Earnings
These are the main line items that make for a functioning balance sheet.
Working Capital Line Items
Accounts Receivables, Inventory, and Accounts Payables are unique in that they have a very specific method of forecasting. Because these accounts are all involved in the operating and cash cycle, it is useful to forecast days outstanding for all of these accounts. Using the formula for their respective days outstanding, we can forecast future accounts receivables, inventory and accounts payables.
- The following are the formulas for annual days outstanding:
- Accounts Receivable Days = Average AR / Sales Revenue x 365
- Inventory Days = Average Inventory / Cost of Goods Sold x 365
- Accounts Payable Days = Average AP / Cost of Goods Sold (or Purchases) x 365
After finding historical values for days outstanding, we can use these trends and reverse engineer the days outstanding formulas to find the accounts receivables, inventory or accounts payables for that specific period.
Working Capital Example
Let us take an example of accounts receivables. In the previous year, accounts receivables days was 120. If sales revenue was $100,000 for the year, then accounts receivables is found by:
- Accounts Receivables = 120 x $100,000 / 365 = $32,876
When these forecasted values deviate materially from actual values, we need to examine the elements of the calculation.
- Are customers paying slower or faster?
- Have we accurately captured sales or has the nature of the sales changed?
- Are we offering different terms?
Other Current Assets and Long-term Assets
We can forecast other current assets as a single line item, or break them out as individual items. Projecting balance sheet line items through the latter method is a bit more involved, but will allow for more granularity and dynamism in the model.
The quick and dirty method of project balance sheet line items for current assets is to simply use a whole dollar value prediction for these accounts in the future, or follow the trend that already exists.
Property, Plant and Equipment
Projecting PP&E is different from projecting other current assets and long-term assets. This projection requires deriving the depreciation schedule fro your ERP for each class of PP&E. Then, place known future new capital purchases into the appropriate period and manually add its depreciation to the system-provided number for those periods budgeted. The balance displayed on the balance sheet is the closing balance.
- Closing balance = Opening Balance + New Capital Expenditures Planned – Depreciation Expense
As you can see, the use of the depreciation schedule is tied to both the balance sheet and income statement. We use the closing balance on the balance sheet and the depreciation expense in the income statement.
Similarly to PP&E with its depreciation schedule, Long-term debt is forecasted using the debt schedule. This schedule outlines each class of borrowings and lays out the interest expense for each period. The balance displayed on the balance sheet is also the closing balance of long-term debt, or the sum of all the closing balances of individual debt.
- Closing balance = Opening Balance + New Debt Planned + Interest Expense – Repayments
It’s important to note that here; interest expense is added back to the opening balance. In contrast, depreciation expense is deducted from the opening balance under PP&E. Keep this in mind, and don’t forget to use the appropriate signs.
Shareholder capital can be one of the simplest tasks when projecting balance sheet line items. More often than not, shareholder capital remains constant throughout periods, so forecasts will generally just be set to equal the latest known period.
- Closing balance = Opening Balance + New Capital Issued – Capital Repurchased
Forecasting retained earnings actually involves projecting net income and dividends, rather than retained earnings itself. This means that to finish projecting balance sheet line items, it’s handy to first finish projecting income statement line items so as to have net income readily available. As always, the balance that is displayed on the balance sheet is the closing balance.
- Closing balance = Opening Balance + Net Income – Dividends
2. Projecting Income Statement Line Items
Current Assets and Liabilities
In the example above, we calculated Working Capital. These items will be the “activity” affecting beginning and ending balances of Accounts Receivable and Accounts Payable. In calculating working capital, we made assumptions first and foremost about projected sales and it’s timing. This may come from your sales organization in the form of a sales pipeline and from your ERP regarding recurring revenues from existing customers and their patterns. Combining these disparate sources can sometimes be a bit of an art, and it is a process many organizations repeat monthly – some may do it weekly. These “reforecasts” may be periodically fed into your budget planning model to see how changes need to drive changes in plans.
Allow changes in sales forecasted drive the other items in working capital, i.e. what changes are made to the inventories I need on-hand. How do these new sales numbers affect my credit limits with vendors? How will revised sales affect my cash needs?
Look to your ratios and balances:
- Do days outstanding radically change using actuals and projections?
- Do the balances fluctuate radically?
If either of these are happening, your assumptions may need adjusting – or you may have a radical change going on with your business.
All other revenues and expenses
Populate the remaining line items based upon historical balances, weighted towards the ending trends. Incorporate known changes.
This really is your basic budget process. Your budget should be a living document. With each period close, update the assumptions. Many organizations will replace calculated periods with “hard keyed” actuals. Refine the assumptions. Rely upon your ERP, your sales organization, your vendors – all external and internal resources. Use the budget as a repository of your collective understanding of your business dynamics. Revise it to always make it relevant.
Need help? We believe that your budgeting and forecasting software solutions should serve to support your enterprise in understanding how on-going activities will contribute to delivering on your longer term strategy. Strafford has the consulting, cloud hosting and EPM support services experience to help you achieve your goals and help you become strategic partners to your business.