What is typically the first step in preparing a budget?

Setting sales and revenue targets is typically the first step in preparing a budget because it provides the foundation upon which all other budgetary decisions are based. By establishing expected sales and revenue, an organization can make informed estimates about the resources needed to support those targets. This process involves understanding market conditions, analyzing customer demand, and considering any strategic initiatives that may impact sales.

Once these targets are clear, it becomes easier to allocate expenses, set production levels, and estimate cash flow requirements. The focus on sales and revenues at the outset ensures that the budget aligns with organizational goals and reflects the expected economic environment, making it a critical starting point in budget preparation.

Other options represent important steps in the budgeting process but usually follow after establishing sales targets. Variance analysis is more relevant during the budget review process to assess performance against the budget. Compiling previous years’ budgets is useful for reference but primarily serves as a tool for comparison rather than a foundational step. Lastly, forecasting cash flow needs is essential for financial planning; however, without understanding the anticipated revenues, it's challenging to make accurate cash flow forecasts. Hence, establishing sales and revenue targets stands out as the essential first step.