At the heart of every finance job in an organisation is the need to keep track of and communicate the state of its finances in a meaningful way to managers and the board. So you might be forgiven for thinking this should be well-rehearsed and straightforward. But there are a number of obstacles to overcome.
The first is that everyone has a slightly different understanding of what they mean by the term "budget". For some, this means simply the financial version of the plans. For others, it provides managers with the authority to spend in accordance with a budget approved by the board. It may well have characteristics of both, but the really important point to note is that a budget without written assumptions is about as good as a random set of numbers. The discussion about the budget really needs to be a discussion about the assumptions, with both managers and trustees involved. Once you start discussing the assumptions, you can start to get a feel for whether a budget is conservative or ambitious, whether it presents realistic targets or whether there is considerable risk inherent in the plan.
In fact, most organisations would benefit from an early discussion with the board about the type of budget they would like to see prepared. Do members of the board want to see an ambitious budget, or is this a time to be risk-averse? Would they like to see a base budget describing the commitments we already know about, and then a set of proposals with financial information so that they can make decisions? It's important to get everyone on the same page before you start discussing a draft budget.
The understanding about the assumptions continues to be useful as you use the budget to monitor financial health. If I have understood a budget to be conservative, I will expect it to represent the bottom of the range in terms of actual results. So loud alarm bells should be sounding if performance is less than budgeted.
If I have written assumptions, it will be much easier to analyse the variation of actual financial results compared with the budget. Interpretation of the management accounts relies on a good understanding of these variances and their causes. Some differences might be due to timing, but some will be permanent changes that you need to allow for in reforecasting your finances.
With a sound grasp of the organisation's underlying business models, senior managers and trustees can focus on the key indicators of financial health. These will have become apparent as you documented the assumptions, because you need to understand the links between particular income and expenditure items as you prepare a budget. Indeed, some expenditure is not affected by the level of activity, and these are known as the fixed costs of the organisation. Those costs can be reduced only over the longer term and after decisions to close some operations.
So this is just a reminder - words are just as important as numbers.
Kate Sayer is a partner at specialist auditors Sayer Vincent