First in a series of three articles, “Budget Building Blocks,” Reprinted with permission by Donald Keninitz, CPA.
One of the most overlooked considerations in the management of a business is the importance of a comprehensive operating budget. This is especially true in the case of government contractors, many of which are relatively new businesses and thus preoccupied with seemingly more important matters, such as obtaining new contracts. Frequent objections to the development of an all-encompassing operating budget include the following:
Lack of understanding of benefits
Lack of time
Inability to reliably predict future events, such as contract activity and related direct and indirect costs
Lack of understanding of the budgeting process
Absence of qualified financial support personnel
Let’s begin by addressing each of these objections. First, it’s crucial to understand the many benefits a detailed operating budget can bring to an organization. These include the following:
Providing a “road map” for achieving a company’s goals (there’s an old adage that applies here: if you don’t know where you’re going, you’ll never get there!)
Providing a baseline for measuring performance, both for the business as a whole as well as for individual managers
Facilitating the development of a pricing model for use in responding to RFP’s
Increasing the likelihood of recovery of costs by helping to ensure that contracts are priced appropriately and that provisional indirect rates reflect the expected reality
Contributes to compliance with Government regulations requiring that contractors have an adequate estimating system
Assisting in obtaining external financing by demonstrating a commitment to sound business practices; also, an operating budget can ease a potential lender’s fears about the quality of the company’s financial management skill
The excuse that an organization lacks the time to prepare a detailed budget is almost always an unfounded one. The real reasons usually have more to do with a failure to treat budgeting as an important organizational priority with more benefits than costs. A business that is committed to the budgeting process and that begins the process well in advance of the budget period will find that the necessary time is available.
Many businesses are willing to recognize that budgets are important, but nonetheless feel helpless in preparing them because of a perceived inability to forecast future events. This feeling is usually based on the common fallacy that the purpose of budgets is to predict the future, when the real purpose is to set organizational financial goals and then set in motion the processes for achieving them. For example, a frequent complaint is that the organization can’t possibly know the number and magnitude of the contracts it will win and thus cannot forecast its revenue. An operating budget examines factors such as a company’s expected proposal activity, its expected success rate, and the timing of contract performance. In effect, the business seeks to control events rather than merely being controlled by them. It isn’t fatal if things don’t go as planned; part of the purpose of budgeting is to facilitate the identification and implementation of remedial action to permit the achievement of goals.
Two additional objections that go hand in hand center on the absence of qualified financial support personnel and a lack of understanding of the budget process. These can indeed pose a problem for a young contractor. It should be understood by every organization that one of the first orders of business consists of hiring a qualified CFO or controller and implementing appropriate accounting and reporting systems. Although this may seem like overkill for a very small company, it is the foundation on which future financial management success is based. Experience demonstrates emphatically that attempted cost-cutting in this area provides short-term savings at best and inevitably leads to additional costs in the long-run. Proper understanding of the budgeting process may require an organization to seek outside professional assistance. Most businesses will find this assistance to be well worth the cost given the benefits of a comprehensive operating budget, as described above.
In future articles, we’ll look at some of the specific components of the budgeting process, including revenue estimation and the differences in preparing direct and indirect budgets.