Accounting Best Practices, Fifth Edition

5–2. Clearly Define All Assumptions

When the budget model is first presented to senior management, the person doing the presenting is deluged with questions about what assumptions are used in the model. Examples of assumptions that can cause problems are tax rate percentages, sales growth rates (especially by product line, since some of those lines may be exceedingly mature), capacity levels (see the next section), cost-of-goods-sold margins, commission rates, and medical insurance rates per person. Upper management wants to make sure that all assumptions are reasonable before they spend a great deal of their time reviewing the presented information. If there are specious assumptions, they will probably kick the budget back and demand changes before they will agree to look at it.

The best way around this problem is to list all key assumptions either right at the top of the budget model or else in clearly noted spots on each page. It is also helpful to note how these assumptions have changed from previous years, either by providing this information in a commentary or by showing prior year information in an extra column in the budget. By providing this information as clearly as possible, there will be fewer questions for the budgeting team to answer.

An even better approach is to tie as many of these assumptions into the budget model as possible, so that a change to an assumption will result in an immediate ripple effect through the budget. For example, changing a tax rate assumption ...