Complete Guide to Financial Budgeting

Complete Guide to Financial Budgeting, Budgeting Training Dubai

Complete Guide to Financial Budgeting and how it will help you achieve Organization Goals

Complete Guide to Financial Budgeting: Financial planning, forecasting and budgeting process is an ART, not a science and there is a saying “If you fail to plan, you plan to fail”

Budgeting and Responsibility Accounting – Financial Planning

Why go through this process?:

  • Investor confidence
  • Insight to top management
  • Manage and drive business performance
  • Better understanding of business risks
  • Responsibility & accountability

The task of determining how a business will afford to achieve its strategic goals and objectives. The Financial Plan describes each of the activities, resources, equipment and materials that are needed to achieve these objectives, as well as the timeframes involved.

It provides the rigor by confirming that the objectives set are achievable from a financial point of view. It also helps to set financial targets for the organization, and reward staff for meeting objectives within the budget set.

What is Financial Budgeting and Why Is It Important?

Financial budgets allow us to plan our business income and expenses in order stay ahead of any adverse scenarios in future. Budget planning also helps us to mitigate risks involved if a certain revenue levels are not achieved.


Forecasting is a decision-making tool used by many businesses to help in estimating future. In the simplest terms, forecasting is the attempt to predict future outcomes based on past events and management insight.

There are two forecast types: judgment-based and quantitative (e.g. statistics). The most trustworthy forecasts combine both methods to support their strengths and mitigate their weaknesses through Financial Planning, Forecasting and Budgeting Training in Dubai.

Judgment Forecasting

  • Uses intuition and experience.
  • Our minds are able to make connections and understand context in a way that no computer can
  • Prone to certain biases
  • Difficult to analyze large amounts of data
  • Best where there is little to no historical data

Quantitative Forecasting

  • Uses analytics on large amounts of historical data to discern trends and patterns
  • Less prone to biases
  • Excellent at analyzing large amounts of data
  • Weakest when there is little to no historical data

How to Get Started with Budgeting

If you are in process of creating a monthly or yearly budget you must have proper training/ knowledge on how create a budget in excel or any budgeting application.


Judgment Gut feel / Intuition • Launch of new product

  • New business area
  • Competitor action
  • Moving Average Average of past actuals to project future • Sales for a product with steady demand
  • Expense budgets of routine items (office supplies etc.)


  • Smoothening Capture trends and patterns.
  • Gives weightage to recent data • Sales for a product with seasonality / fluctuating demand
  • Periodic expense items


  • Analysis Relationship between factors
  • Marketing spend and sales
  • % of sales / cost etc.
  • Statistical Tools Many computerized tools Multiple uses


The word “budget” is derived from the old French “bougette”, meaning a small purse. In the mid-1700s, Great Britain’s Chancellor of the Exchequer was said “to open the budget” when presenting his annual statement. The term was extended to private and commercial finances in the late 1800s.

Useful Tips for Effective & Efficient Process

  • Clear assignments of responsibilities
  • Collaboration & Communication
  • Top Down vs Participatory
  • Timelines (FBI agent 233!)
  • Budget Templates
  • Accuracy vs Estimate
  • Central repository


  • Operational planning Strategic planning
  • Immediate forecast Trending
  • Less uncertainty More uncertainty
  • Focused on targets Focused on big picture
  • Sensitivity analysis – micro Sensitivity analysis – macro
  • Which one comes first?

Short Term vs. Long Term

  • Top line growth by 15% by next year Short Term
  • Achieve a CAGR of 10% in 5 years Long Term
  • Increase market share to 20% in 2015 Short Term
  • Become the market leader and brand of choice Long Term
  • Investment plan for an ERP system Short Term
  • Investment plan for continuously increasing production capacity Long Term
  • Improve diversity in the workforce by 15% Short Term
  • Become among the Top 10 best places to work in the country Long Term

Fixed vs. Rolling – Types of Budgeting

  • A Fixed budget is set for a specific time period which is then locked.
  • A Rolling is also for a time period but keeps moving ahead as time passes. EXAMPLE:
  • Fixed: Budget for 12 month period from Jan to Dec 2015
  • Rolling: Budget for immediately preceding 12 months. As each month ends, the budget gets updated for the next 12 months


  • Once the budget is approved, the numbers are locked (target control) Future numbers / targets keep changing (no target control)
  • By the time budget is approved, it may be outdated Always up to date
  • Unutilized budget does not carry over Unutilized budget can be utilized
  • Usually tied in with financial time period instead of business cycle Takes into account business cycle / seasonality
  • Once a year “blitz” activity Time consuming and expensive
  • Closer to the budget period end, focus becomes very short-term Keeps the focus on the entire future period
  • Difficult to manage working capital requirements as time goes by Easier to manage working capital requirements as continuously updated
  • One time opportunity for manipulating Greater chances of manipulating

Incremental vs. Zero Based

Incremental budgeting extrapolates from historical figures adjusting for expected changes in various factors / assumptions (e.g. inflation, exchange rate, fuel and other costs, manpower changes etc.).

  • Easy
  • Fast
  • May inflate budgets unnecessarily
  • May create motivations to utilize budgets unnessarily

Types of Budgeting

Incremental vs. Zero Based

Zero Based budgeting also called ground-up budgeting, uses the assumption of budget allowance of ZERO unless appropriately justified otherwise.

  • More detailed and in depth analysis required
  • Time consuming
  • Critical evaluation to allow only necessary budget
  • Starts with a zero budget every budget cycle regardless of the budget utilized previously

Kaizen Budgeting

Kaizen is a Japanese term that means continuous improvement. Kaizen budgeting attempts to incorporate continuous improvement into the budget process. For example, cost reductions are built into the budget on an incremental basis so that management tries to continuously reduce costs over time. If the costs are not reduced by a particular function as per budget, extra attention is given to that function.

  • Develops an attitude towards improvement
  • Critical review of costs / new ways to generate revenue
  • Difficult to sustain once low hanging fruits are utilized


  • A purchasing department may budget for a continuous reduction in the cost of raw material to reduce cost of production as follows:
  • Incremental budgeting may not allow extrapolation for full inflation to force thinking of continuous improvement

Master Budget

Master budget is the ultimate “culmination” of the budgeting process for the company. It is the summary of all individual budgets into one final set of budgeted income statement, balance sheet and cash flows.

To prepare the Master budget, following are used:

  • Operating budgets (revenue, GOGS, administrative costs etc.)
  • Financial budgets (cash flows, working capital, financing, capital investments etc.)

This is the final check to ensure all information is flowing back-n-forth properly

Setting Assumptions

  • Inflation
  • Exchange rate
  • Fuel / Transportation costs
  • Interest rate / Discount rate
  • IRR
  • Others

Source: Harvard Business Press – The Essentials of Finance & Budgeting

Controls in Financial Budgeting

Variance Analysis

  • Comparison of actual results with budget
  • Control Framework to manage business performance
  • Only works if action is taken and budget is realistic Plan


Control Monitor


Why do variances occur?

  • Difference in assumptions vs. actual results
  • Changes in volume / size
  • Incorrect budgeting
  • External / internal factors not predicted
  • Mathematical errors
  • Incorrect computation of actual results
  • Others?

Evaluating Variances

  • Positive vs. Adverse
  • Foreseen
  • Foreseeable
  • Materiality
  • Cause
  • Temporary (one-off) vs. Permanent (new trend)
  • Management By Exception

Variance Analysis – What to Avoid

  • Using different basis for budget and different for actual
  • Ignoring the cause of the variance
  • Accounting records vs. own records
  • Immaterial variances
  • Punishing all variances – The Blame Game
  • Are all adverse variances bad?

Variance Analysis – Fixed Budgets

  • Traditional variance analysis
  • Approved budget compared to actual results
  • Event Oriented Reconciliation (EOR)
  • Action steps identified and implemented
  • Determine if any change needed in budget for remaining period
  • Regular activity

Flexible Budgets

  • Adjusted for volume
  • Understand Variable costs vs. Fixed costs
  • More realistic picture of the actual variance
  • Prepare a flexible budget and variance with actual results

Prepare following for the Home Theatre jobs:

  • Difference in Profit between Original Budget vs. Flexible Budget
  • Price Variance – Revenue
  • Price Variance – Material Cost
  • Efficiency Variance – Material Cost
  • Price Variance – Labor Cost
  • Efficiency Variance – Labor Cost

Cash Budgeting

  • Why the need when profit / loss is already calculated?
  • Revenue vs. Receipts
  • Expenses vs. Disbursements
  • Periodic vs. Continuous
  • Capital investments
  • Financing / Investment requirements
  • Cash Budget
  • Financing requirements

Sensitivity Analysis

Sensitivity analysis is a way to predict the outcome of a decision if a situation turns out to be different compared to the key prediction(s). Planning, forecasting and budgeting involves many assumptions and predictions. Therefore, it is essential to do a “what if” analysis to determine what further actions are needed in case some of the “assumptions” did not hold true

Key Uses

  • Cash flow planning
  • Funding requirements in Financial Budgeting
  • Surplus investments
  • Funding type
  • Decision making
  • Launching a new product / new business
  • New investment
  • Hedging
  • Reviewing costs

Types of Analysis

  • Scenario Analysis: outcomes based on a combination of assumptions
  • Simulations: probabilities of different possible outcomes
  • Break-even analysis: combination of assumption at which indifferent

Capital Budgeting and Analysis in Financial Budgeting

Capital Budgeting is the process by which organizations evaluates and select which real investment projects should be accepted and given an allocation of funds. To evaluate capital budgeting processes, their consistency with the goal of shareholder wealth maximization is of utmost importance.

Why Capital Budgeting and Analysis Important

  • Long – term decisions
  • Tied to strategy / objectives
  • Involve significant amounts
  • Critical to company’s future
  • Timing is key
  • Investment
  • Decision
  • Reinvestment Real Assets
  • Returns from Investment
  • Financing Decision
  • Refinancing Financial Markets
  • Returns to Security Holders

Process of Capital Budgeting and Analysis

  1. Identify
  2. Categorize
  • Replacement (sustainability / efficiency)
  • Capacity Enhancement
  • New Business
  • Safety / Environment


  • Payback
  • Discounted Cash Flow (DCF)
  • Net Present Value (NPV)
  • Internal Rate of Return (IRR)
  • Profitability Index

Fundamentals of Evaluation

  • Independent Projects: Cash flows of each project are not affected by each other
  • Mutually Exclusive Projects: Cash flows of one project are adversely affected if the other project is accepted
  • Normal Cash Flows: Cost in first year (cash outflow) followed by a series of cash inflows in the subsequent years. One change of sign
  • Non-Normal Cash Flows: Cost in first year (cash outflow) followed by a series of cash inflows in the subsequent year and then cost in last year to close the project. Two or more sign changes

Capital Budgeting and Analysis – Payback

The number of years required to recover a project’s cost DECISION MAKING:

  • Independent Projects: Set a criteria (e.g. Accept all projects with payback period less than X years)
  • Mutually Exclusive Projects: Select the project with shorter payback  period


  • Very easy / simple
  • Provides quick indication of a project’s risk and liquidity


  • Ignores time value of money
  • Ignores cash flows AFTER the payback period

Discounted Cash Flow

  • The number of years required to recover a project’s cost, taking into account the time value of money
  • Uses the discount rate to calculate present value of future cash flows
  • Discount rate = interest rate earned on investments (opportunity cost)

Net Present Value

Difference between present value of expected future benefits of entire project to present value of expected cost of entire project


  • Independent Projects: Select the project with NPV > 0
  • Mutually Exclusive Projects: Select the project with higher NPV


  • Incorporates time value of money for the entire lifetime of the project
  • Easy to interpret
  • Consistent with the objective of maximizing shareholder value


  • Relatively complicated calculation
  • Requires assumption of discount rate (which may change)

Internal Rate of Return

The rate at which NPV will be ZERO (break-even) DECISION MAKING:

  • Independent Projects: Select the project with IRR > Discount Rate
  • Mutually Exclusive Projects: Select the project with higher IRR


  • Incorporates time value of money for the entire lifetime of the project
  • Easy to interpret
  • Consistent with the objective of maximizing shareholder value
  • Calculations do not need any assumptions of discount rate


  • Relatively complicated calculation in Financial Budgeting

Profitability Index

Ratio of PV of benefits of investment to PV of cost of investment PI = PV(benefits) / PV(costs)


  • Independent Projects: Select the project with PI > 1.0
  • Mutually Exclusive Projects: Select the project with higher PI

Capital Budget Rationing

  • High cost of capital and limited financing availability
  • Risk appetite / Investor Reactions
  • Maximum CAP on the amount of capital investments in a given year
  • Indirect costs associated with raising capital

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