Why is Budgeting and Business Planning Important? - budgeting is one of the most important management processes. It aims to assist professionals in planning ahead to make judgements on how well the firm will perform. Owners of well run businesses create, manage and review the budgeting process including a monthly sales forecast of their products and services. The main reasons simple budgeting is fundamentally important to any organisation are as follows:-
-
Underpins Financial Controls - creating a budget planner system helps to establish tighter financial controls which in turn provide accounting ratios, trend analysis and graphs of the key metrics. In simple terms budgeting is a control mechanism. By having a control mechanism to compare actuals to your monthly budget you are in a position to take corrective action if necessary.
- Facilitates Performance Measures - all entrepreneurs need set their own financial targets and goals so that they can understand where the business is going and what it needs to achieve and by when. Variances against targets can be quickly identified either company wide or by function. For instance salespeople need sales targets. Credit control managers need targets related to the collection of outstanding unpaid invoices. Production managers need targets related to stock control and lead times. So regardless of the size of a company there are not many job description whose performance could not and should not be measured against targeted budgets in some way.
-
Dictates Management Behaviour - business budget restrictions focus managers minds on allocating limited resources in targeted ways to help grow the firm, reduce operating expenditure, manage cash flow and improve profitability. Targets help anticipate problems and focus on making continual improvements. Budgeting is the linchpin between revenue forecasting and managing finances to achieve that sales aspiration. Both teams and individuals need to know what the boundaries are on their individual spending limits, to achieve the sales target and whether any rash investment decision would result in cash flow problems for the firm.
-
Helps Maintain Liquidity - the annual business plan should clearly define and overall financial picture of where the enterprise needs to be next year and beyond. The plan should split out all financial aspects of your activities including profitability and cash flow. Make sure you understand the difference between a profit and loss account and the cash flow statement. The operating statement is a simple snapshot of profitability of the business at any given point in time and ignores liquidity. Yet for most small businesses cash is king. Accurately monitoring the working capital on a daily basis is ultimately more important than forecasting longer-term profitability. Here tracking cash flows against a monthly forecast can help to motivate staff to chase outstanding debtors for payment of invoices as well as negotiate for better credit terms with trade suppliers.
How to Create a Business Budget - the first step is to create a sales forecast. This should detail what products or services you are planning to sell at a given unit price and the expected volume of units sold on a monthly or quarterly timescale. Breakdown turnover budgets by geographic area and also by product or service (if you are selling more than one item). For businesses that have a trading history the basis of their sales budgets should be historical data. However for new start-ups creating a sales forecast will be particularly difficult as no historical data can be used as a benchmark and reality check. Entrepreneurs will have to use qualitative and quantitative market research data linked to a comprehensive marketing plan.
Next you should estimate your overall costs which are based on assumptions you have made in your selling budget. You will need to split out expenditure between direct variable 'production costs' (associated with your sales budget) from the (relatively constant) 'overhead costs' of the firm. Production costs are usually made up of items such as raw materials, sales commission, subcontractor services, customer discounts and depreciation.
For businesses that require large investments in capital equipment such as machinery, tools or buildings most will obtain a commercial loan or commit a long-term lease. As the payments on these vital commitments are normally fixed by a contract, it's vital these production related costs are allocated correctly in any monthly, quarterly or annual expenditure budget to avoid missing repayments. By adding up all these items and dividing them by expected sales volume units you will be able to construct a unit cost per the sale.
Your overheads budget will be made at all items such as rates, rent, salaries, pension contributions, business insurance, business telecommunications and interest on any business loans. Most of these items do not vary by sales volume and are therefore remain at a more constant level overtime. Service-based businesses will generally have higher levels of overheads relating to sales than manufacturing-based businesses and vice versa.
Next you'll need to construct a cash flow budget. To remain solvent and in control tracking cash flows in and outs of your small business will become your most important priority. The cash flow budgeting process should help determine your working capital requirements for the year ahead as well as provide your business banking manager with a greater degree of confidence that you understand the realities of business finances and managing money. The main cashflow concern if late payment of invoices. Most businesses do not always receive payment for their goods or services immediately and have to wait for customers to pay invoices. As a result cash flow problems may arise if the business does not have sufficient means to remain in the black. Consequently most firms have to rely on overdraft facilities or business loans to plug any cash flow shortfalls. By plotting a monthly cash flow forecast using your sales budget, production budget and overhead budget, it is easy to identify problem months ahead.
The budgetary process is ongoing and involves most senior and middle managers to review and update their own departmental budgets. Most small firms would sensibly allocate scheduled time to devise and review budgets and keep a monthly breakdown to check off results against original forecast.
Budgeting Tips Using Personal Finance Software - you could develop your own budget spreadsheet calculator planning tool to help organises your firms finances or alternatively you could invest in a popular off the shelf accounting software package. Financial data must be constantly collected and organised for bookkeeping processes. This data can then be entered into popular software accounting packages such as Sage or QuickBooks to log all sales and costs, receipts and payments and assets and liabilities. This bookkeeping software can be used in the money management process to help transform financial data into easy to understand accounting ratios using graphs, charts and budget planner tables. This management information helps identify variances between budget and forecast. In addition personal finance software is ideal to keep track of every penny thereby reducing human error in the book keeping process for the cashbook account, VAT returns, profit and loss and balance sheet updates. So keeping on top of the big picture helps avoid unwanted nasty surprises (such as additional overheads that weren't originally budgeted for).
Controlling Costs - to improve profitability any reduction in 'wasteful' operating expenditure can help improve margins. All firms inherently have waste and inefficiency which could be reduced. Therefore setting a challenging operating expenditure budget can change people's behaviours. For instance cutbacks force people to think creatively about the best ways to spend money, be more frugal and ask for discounts, think before acting on impulse and generally make sure every pound spent contributes towards the companies goals. Cost control is usually about prioritising by necessity while eliminating 'nice to have' expenditure items. It is a responsibility of everybody in the business and yet can feel unpleasant or even unnecessary. Indeed being too cautious may even become a 'false economy' restricting organic sales growth through cutbacks in advertising or recruitment.