How To Effectively Your Budget Should I take budgeting seriously, and what can it do for me?
By Ed Hatton
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A budget is or should be a part of your business plan. It is one of the major control methods to make sure your plan is implemented rather than ignored. I agree that there are some very successful businesses that operate on a seat-of-the-pants basis, but there are a lot more trying to do so but instead floundering around in the dark.
Unless you are gifted with unerring judgement and great insight you are likely to achieve more success by working to a plan and budget.
Budgets are often prepared by financial managers and tend to focus on operating and capital expenditure rather than sales, purchases, inventory and debtors targets. A better approach is to start by agreeing what performance your company would like to achieve for all key areas of the business.
The sales budget could be a separate section of the main budget to manage expected sales by whatever breakdown suits your business:
- Type of product
- by division
- branch or sales channel, or type of customer.
In each category budget for margins, discounts and commissions.
Expenses
Key expense items like payroll, overtime, marketing promotions, travel, vehicle expenses and IT costs should be planned for and monitored via the budget but I suggest you don't clutter the expense budget with too many items which you have little power to manage. Rather lump these together, you can always drill down if the costs get out of hand. If you have a seasonal business with variations in sales and expenses depending on the time of the year, make individual budgets per month.
Do not forget balance sheet lines, especially capital expenses for new buildings, machinery or vehicles, and also borrowings and other liabilities. Debtors, creditors and inventory should all be planned and monitored and it is a good idea to monitor measures like average days outstanding for debtors and creditors, days inventory held, bad debts and obsolete or lost stock.
The last items can be target ratios which may not form part of the budget, but should be reported on regularly so that you do not get nasty surprises at the year end. Prepare the budget with everyone concerned to get buy-in. The budget becomes an agreed plan of operations to which everyone is committed.
Budget review
Monitoring performance against budget should be done at least quarterly but I prefer once per month in a management meeting. If you are the only manager, set aside time each month to review your performance against budget, and don't skip that time. The actual results must be up to date and available. Use a simple spreadsheet showing budget, actual and variance or a dashboard which shows key metrics as graphics or tables.
Examine those items where the variance to budget is significant and probe for reasons. The dangerous ones are the start of a trend — for example sales in one area consistently below budget or mushrooming overtime costs. For any bad variances that are not just a short-term hiccup you should plan to correct the problem, or if the problem is insurmountable, replan to get around it.
The budget can be changed because circumstances are different to those envisaged when the budget was prepared, but a better option is to add another column for a revised budget, so the amount of the change remains obvious. Managing the budget should not be limited to complaining about excessive entertainment or travel costs, but a vital tool to give stark visibility to key areas of the business that are not performing as expected.
It should involve all the key players in decision-making to catch and fix problems early, but also to seize opportunities presented by better-than-expected performance at the earliest time. Treat budgeting as a management tool and it is likely to treat you to more profit and less nasty surprises.
