The budget is a critical planning tool for an organisation. When developing a budget, it is important to be as concrete and specific as possible about future income and expenditure. The budget must consider direct and indirect costs and enable the organisation to allocate and plan for the coming year. Budgets are prepared before the start of the financial year, so unknown factors need to be predicted. Budget analysts review historical trends as well as make assumptions about upcoming expenses to try and accurately predict the organisation's financial situation for the year ahead.
Budget predictions are impacted when actual revenue received is not as much as originally anticipated. External factors negatively affecting assumed revenue might include an economic downturn, unexpected competition causing lowered sales or an inability to sustain the level of growth needed. Internal factors such as inadequate collections and poor accounts receivable practices could also impact revenue. Aggressive projections that assume a high rate of growth or increased revenue have a much greater potential for inaccuracy than conservative estimates based on data from previous years.
Expenditure may be one of the most difficult areas of the budget to predict. Increases to health insurance, turnover levels and collective bargaining in unionised organisations can all change salary and benefits by a significant margin. In many industries, salary and benefits is more than 50 per cent of the organisation's total expenses. Any variance to employee compensation will have a noticeable impact on budget predictions. Other unanticipated expenditures may include rent increases, a previously unforeseen need for overtime and financial audit fees and fines.
The economy and current market conditions can impact the financial forecast in several ways. Changes to the inflation rate and stock market conditions directly affect the organisation's net worth and its ability to generate funds or loans. If the company relies heavily on investments as a funding vehicle, then poor stock market performance will have a direct, negative effect on budget predictions. Likewise, if the rate of return on investments outperforms the prediction, then the budget will have a surplus.
Certain legislative changes have a direct impact on budget projections. In most cases, businesses will be aware of pending legislation before it takes effect and can plan accordingly. Sometimes, just the introduction of future legislation, even if it has not taken effect, will disrupt current budget projections. An example of this was the introduction of Governmental Accounting Standards Board (GASB) legislation related to retirement and other postemployment benefits. Although the legislation did not take effect immediately, the impact of the future legislation was clear. It immediately revealed that local governments would have millions of dollars of unfunded liability under some of the proposed rules. Consequently, the organisations' bond ratings started to take into account the potential liability and some were downgraded as a result, hampering ability to borrow money and directly impacting cash flow. Another example of an immediate legislative change that impacts budget forecasts is a change to taxation.
- Commonwealth of Massachusetts Department of Revenue: Quarterly Budget Projections
- Center for State and Local Government Excellence: After GASB 45: Solving the Unfunded Liability Problem in Retiree Health Care
- GOVERNING: New Proposals for Pension Books
- Society for Human Resource Management: Salaries as a Percentage of Operating Expense