Iterative Budgeting

Iterative budgeting is an attempt to combine the best of both top-down and bottom-up budgeting. In the initial step, senior management provides section heads with a clear understanding of the company’s strategic goals.

Departmental or section heads must, when developing their budgets, ensure that they include the strategic goals of the section and the larger, strategic goals of the company into their budgets.

Once you have submitted the department’s budget, top management will review the budget and may ask for some changes to be made. This process of negotiation will continue until a master budget is achieved.

The key to successful budgeting is communication. Senior management must pass on the strategic goals of the company in such a way that they are understood and applicable to the individual departments.

Budgetary slack or padding happens when managers believe they are going to be judged on their department’s performance in terms of the budget. To ensure that they achieve the budgeted figure and are rewarded, they develop unadventurous budgeted incomes or overstated budgeted costs.

Budgetary slack also provides a hedge for managers against unexpected crises, reducing their risk of failure. Budgetary sandbagging is similar to padding, but the distortion can be something other than the presentation of lower than expected sales figures or higher costs. This happens when a manager hides the true intent of a budget.

Let’s now look at the preparation of an Incremental Budget.

The steps are as follows:

Review Last Year’s Data

It is necessary for you to consider the actual results from last year; unless of course, you are starting a new venture, in which case there would be no data to review. The most important indicators for the future come from the most recent history.

This means that the more information you can gather on past events, the more effective the projections for the budget will be. So, let’s take a look at this:

Say you wanted to project the future growth of your company. To do this you decide to use the income only. The income increased by 10%. You need to know what that increase in income was due to. You may find that it was due to an increase in sales and a decrease in the cost of raw materials.

This puts you in a far better position to make some reasonable assumptions about the growth in the company’s revenue. You would also be able to make reasonable assumptions about the cost of goods sold.

Develop Reasonable Assumptions

If you have done your job properly in reviewing the data of the past year, you will have a reasonable idea about the future. You could possibly assume what the growth of your sales will be in terms of products or services. Other factors that you could assume growth from would be:

• Demand
• Labour
• Economic/geographical/demographic or cultural factors
• Company downsizing
• Labour unrest
• Income and expenditure

These assumptions can be developed through the use of data from the past as well as all the appropriate sources of information about the future. Reading the likes of trade journals and subscribing to economic forecasting services will give you the insight necessary. Taking sales into consideration, it would be beneficial to talk to key members of the sales department. For costs of raw materials, talk to people who are involved with the buying in your company. You may also consider your competitors' activities.

Calculate Anticipated Operating Revenue

Once you have examined all the data and developed your assumptions, you will be ready to determine your projections. You may want to develop a stretch budget, which is difficult but not impossible. Maybe you would rather keep it simple, but in all cases, your projections must be reasonable and within the constraints of the production capacities. Your expected revenues must include not only the number of products that you expect to sell but also the price at which you intend to sell them. If you plan to increase the price, ask yourself the question; do you expect your customers to accept or resist the price increase?

Calculate the Expected Cost of Goods Sold

The calculation of the cost of goods sold is important that you include both direct cost and indirect costs. Use past data and your assumptions about changes for each of the elements and calculate the costs as follows:

• Cost of materials
• Labour costs
• Machine set-ups
• Machine run times
• Packaging costs
• Storage costs
• Cost of machinery
• Cost of production space

Remember that, if you are part of a manufacturing industry that sells its products, the opening stock will be included.