For an organization to survive, its leaders need to make sure that it has more revenue coming in than expenses going out. They also need to make sure the revenue arrives in time to pay the expenses, or at least they need a plan in case they need more time. The budget cycle is the means through which this process is organized and monitored.
Although modern-day budgeting looks different than it did hundreds of years ago, the cyclical nature still ties back to an era when a lot of the economy was tied to annual growing seasons. To this day, our economic systems continue to revolve around a 12-month period. The same is true for organizations, which organize their financial accounting and reporting around a fiscal year. The timing of the fiscal year typically relates to whatever makes the most sense in terms of the annual cycle of the organization’s activity. In some organizations, the fiscal year is the same as a calendar year: it starts January 1 and ends December 31. In other organizations, like many universities, the fiscal year begins July 1 and ends June 30. Regardless of the specific period, every 12 months organizations are required to provide an accounting of how things have been going for them financially. Many larger organizations are also required to arrange for an annual audit, an independent review of their finances, which helps ensure that what they are reporting is accurate.
While timing and specifics vary quite a bit from organization to organization, a workable general description of budget cycles can be created by separating activities into four quarters, each lasting three months. In the first quarter, finance leaders will have a greater focus on reporting, taking stock of the prior year and preparing reports for review by auditors and other outside groups. After these steps, they will shift their focus to budget formulation, planning the budget for the next fiscal year. In a large organization, this process will begin with the board and/or senior leadership, who will consider the longer-term financial needs of the organization, in addition to ongoing operational needs. Many larger expenses (buildings and information systems, for example, as well as interest on loans) need to be planned for well in advance and need to relate broadly to the entire organization. Leaders also need to make sure that revenues will be sufficient to meet these longer-term needs.
Once high-level goals for revenues and expenses have been set, they may then be divided into financial expectations for the divisions or departments constituting the organization. Departmental leaders will then build out a budget that they think can meet these goals. In some departments, the goals will seem unrealistic, and there will then be some back-and-forth negotiation to land, hopefully, at something more mutually agreeable.
As you might imagine, this process can get pretty contentious. Since organizational leaders are held strictly accountable for living within their budgets, no leader will want to submit a budget that they believe is going to be extremely difficult to meet. So there is a bias toward asking for too much rather than too little. Additionally, leaders who have been through the budgeting process a few times (also known as having “been around the block”) may anticipate they will be asked to improve on an initial budget they submit, no matter how reasonable it was in original form. In these cases, they may pad their initial budget with unnecessary expenses so that it is easier to reduce the budget in later rounds. To help counter some of these tendencies, organizations will often develop philosophies and guidelines designed to help ensure that decisions are made based on the best interests of the organization’s mission, rather than its cleverest negotiators. One common approach is to look at how other organizations staff different departments and services, and use these outside examples to provide benchmarks as to what may be most fair.