afford, wasting valuable management time in the process as well as creating unnecessary ill will among stressed managers.

A practical solution for this situation is to take the best of both methods by providing managers with order of magnitude target numbers for their department that are based on the parameters set forth in the LRP and then let them develop their own detailed budgets using those targets as a guideline as to where their final numbers should come in. Targets can be as simple as two or three key numbers, including revenues from the clients for which they are responsible, total compensation costs, and other out-of-pocket costs. Having department heads or team leaders prepare their detailed budgets within those targets can provide them with a sense that their input is valued by senior management and, in the end, the firm normally ends up with a more feasible plan that will be supported by its key managers.

While setting targets, revenue should be broken down into its major components, including a revenue plan by client, average billing rates for each level of staff working on each client, total hours to be charged to each client, and overall staff utilization rate targets by staff level. When finalizing revenue targets, in general, it is better to develop realistic revenue estimates that are achievable except for certain major catastrophic events and not push them in the target setting process. By doing so, the firm is more likely to build its expense plan at a level that will be sustainable if relatively conservative revenue estimates hold true. When revenue projections are pushed to higher levels to motivate managers to improve overall performance, expenses are likely to be planned at a higher level and the firm will suffer if those more aggressive revenues fail to materialize.

In summary, a well-organized budgeting process will include many, if not all, of the following steps:

Establish the firms objectives first in the LRP process.

Quantify the annual budget for the firm as a whole based on the numbers set forth in the LRP-for both revenue and expenses. The LRP and budget should be formatted in a way that maps exactly to the financial statements of the firm to facilitate monthly reporting against the plan as well as provide a consistent foundation for historical trend analysis.

Break that budget down into departmental level targets that each manager can use to develop his or her own detailed budget. While setting those initial targets, be sure to allow sufficient funding at the corporate level to cover overruns from individual departments that may be necessary to finalize all budgets at the end of the process.

Consolidate initial budget submissions from all departments to determine variances from original targets given as well as the overall plan for the firm in total. Determine, at a high level, how much needs to be cut from expenses (or added to revenue) to achieve LRP targets.

CFO/senior financial management should conduct reviews of the first draft of the detailed departmental budgets to understand key issues and

reasons they might not be able to live within the target they were given. Finance then should provide department heads with specific guidance as to how much needs to be cut and offer suggestions as to the source of such changes (but be careful not to order certain cuts because that will undermine the main objective of this bottoms-up part of the overall process).

Department heads will then revisit their plans and revise them if necessary.

Department heads then make their budget presentation to the CEO/CFO for their review of final plan. To the extent necessary, it is at this point that the department head may negotiate resolutions to any significant variances with the CEO to ensure overall strategic goals of the firm are met.

Once finalized with the CEOs approval, the CFO and CEO should present the budget to the board of directors for final approval. Final numbers then should be distributed to each responsible line manager to ensure that they are fully aware of the final numbers to which they will be held accountable. In an ideal world, all of the steps described would be completed before the commencement of the new fiscal year. However, in practice it is not unusual for final approval to slip into the first quarter of the new fiscal year. In those situations, it is important to ensure that line managers know how to operate while waiting for the budget to be approved, particularly the procedures required to procure emergency items.

VMonthly Forecasting-Updating the Annual Budget* Periodically, the annual budget should be updated to reflect changes in the firms revenues and expenses that occur over time-both the actuals that have been booked year to date and the outlook for the remaining months of the year. Whether this occurs each month or each quarter is somewhat dependent on the volatility of the business, its capital reserves, and managements preference. Updating the budget/forecast monthly, although arguably more labor intensive, provides management with an economic outlook for the firm based on the most current information available. Further, by incorporating the forecasting process into the monthly managerial routine, it becomes more efficient and less of a big project that tends to paralyze finance and management staffwhen it is left to a quarterly update. For the remainder of this section, we presume that the outlook for the firm is prepared on a monthly basis and is referred to as the forecast.

Development of the monthly forecast is much more of a bottoms-up exercise than is preparation of the annual budget because targets for the year already have been established and the validity of the forecast is highly dependent on line managements current assessment of their capacity to achieve their targets given actual performance year to date. When preparing the monthly forecast, consider the following:

Set up a spreadsheet in a financial statement format that shows all major accounts listed in the same order shown in the firms financial statements going down the page, with a separate column for each month going across the page. Array actuals for each month in the appropriate columns and budget (the first time the forecast is prepared) or the latest forecast for each line in the remaining months of the year. Adjustments then will be made to each of the future months based on the latest outlook for each account.

Revenue forecasts must be made by client and must reflect input from each responsible client manager. When the compensation agreement with a particular client is complex, a supporting spreadsheet should be prepared and reviewed with the client manager. In some cases, particularly those where client managers are loathe to take responsibility for the forecast, it may be worthwhile for a senior financial person to sit down with the manager, review the calculations and, in particular, the underlying assumptions, and have the manager physically sign off that the projections are his or her best estimate based on knowledge at that point in time. Physical signatures, when managed properly, can dramatically improve the accuracy of the firms forecast.

Expenses can be forecasted based on direct input from line managers as well as a top-down analysis of the historical run rates for routine expenses (e.g., electricity costs vary from $10,000 to $20,000 per month, depending on the month-simply estimate future months based on historical expenses by month, with a subjective adjustment to reflect any percentage increase in rates or expected usage). In addition to a high-level review by account, financial managers may find it valuable to review the spreadsheet of expenses by vendor for each account to adjust for one-time anomalies past and future.

Balance sheet and cash flow forecasts can be developed based on certain high-level assumptions. Most line items can be computed as a function of revenues or expenses, and the resulting impact on the firms cash flows can thereby be estimated (e.g., A/R balance can be computed based on assumption for days sales outstanding). A financial model that integrates those assumptions into the workbook used to project the P&L forecast should be used so that whenever one assumption changes, its impact on all three financial statements will be computed automatically.

Capital Budgeting. The annual capital budget is a list of approved capital projects and approved dollar amounts. A capital project may consist of either a single item or a group of related purchases that have an expected life in excess of one year and exceed the firms minimum dollar value threshold for capital treatment. For reporting purposes, capital is utilized when an irrevocable commitment is made-not when cash is paid or an invoice is prepared by a vendor or received by the firm.