How to prepare a budget by owen213

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									                                           How to prepare a budget
There you are, running around in small circles with deadlines to meet and bills to pay. Can you really afford the
time required to produce a detailed budget? Isn’t your time better spent generating revenue?
Yes and no. To paraphrase Alice and the Cheshire cat: “If you don’t know where you are going, you are sure to
get somewhere if you only walk long enough”. The budget provides you and your investors with a numerical
map that leads somewhere specific.
What is a budget?
A budget is a forecast of revenue, expenditure and profit. Most budgets are revised annually.
What does it achieve?
There are two (often overlapping) reasons for producing a budget. One is to persuade potential investors that
your company is a good bet. The other one is to plan your business finances - how much money do you have
and how do you plan to use it? How much revenue do you need to generate to achieve your target profit? Is
your business plan viable or does it need adjusting? In retrospect, did the year pan out the way you planned, or
did something go wrong?
How to approach a budget
First, find out how your accounting software deals with budgets. It’s far more efficient to use the same package
for accounting and budgeting. Next, meet your accountant to plan how to structure the budget. Arrive prepared,
with a chart of accounts and a list of informed questions. Take copious notes.
Traditional budgets are very difficult for start-ups and firms with a short history, because there is little or no
historic data. Revenue is particularly problematic, because no matter how carefully you have planned, it’s
impossible to predict the future. There are two main approaches to budgeting:
The projections approach
Here you enter projected costs and projected revenue, and calculate projected profits from these. This is
reasonable and rational if the company has several years of relatively stable history to project from. If it’s a new
company, such a budget is likely to become an exercise in denial and wishful thinking.
The required profits approach
An alternative method is to enter projected expenses, and then calculate how much profit you require, and how
much you think you can actually generate.
Eventually this should be enough to pay your salary and provide a return on your investment in the company.
However, it might be realistic to plan for a loss in the first year or two, and only a small profit for a year or two
thereafter.
Having settled on a number, you now add expenses to profit to come up with your required revenue.
Turn this number inside-out. Is it realistic? Is it achievable? Instead of guessing wildly how many widgets you
may be able to sell, or how many hours you hope to bill, you can now soberly assess whether you will be able to
reach your targets. Don’t have 10,000 billable hours in the year? Can’t afford enough machinery to make a
million widgets? Go back and adjust the business plan.
Once the company is liquid, determine your salary based on what you would be earning if employed in a similar
job, and your return on investment based on the interest you would receive if investing outside the business.
EXPENSES
Fixed costs
Fixed expenses remain the same regardless of sales volume. They include rent, loan repayments, and
insurance.
Semi-variable costs
These are costs with fixed and variable components, such as telephone, salaries and wages. The fixed
component is the minimum cost of supplying goods or services, while the variable component changes
depending on sales volumes.
Variable costs
Variable costs increase or decrease in line with sales, and include costs of materials, distribution and
commissions.
Start-up costs
Initial costs must be factored in for a start-up.
REVENUE
If you use the required profits method outlined above, you will have generated a total figure for required
revenue. This is a goal rather than a prediction. You need to break it down to decide how many of what you
need to sell, what you need to charge, and whether the targets are realistic. It has the added advantage of
generating very clear monthly sales targets.
Once the business has been running for some years, revenue will be predicted in a more conventional way,
based on past performance.
MONITORING THE BUDGET
Once you have set up the budget, compare it to the actual figures every month, to look for differences and
establish why they are there. Adjust expenditure or sales efforts as you go along, to bring the next group of
numbers in line with the budget.
                                   A Guide to Better Budgets
Start simple.
Have each function and area of responsibility prepare its own budget, consistent with corporate goals,
objectives, constraints, and policies.
Recognize that effective budgets require senior management approval and the endorsement of the
organization.
Understand that having a budget improves the performance of the entire organization and each of its
parts— really.
Understand that a budget is developed to ensure that every department head is working toward the
same goal, with knowledge of the department’s resources and constraints.
Recognize that the budget department does not create the budget. It is simply a coordinator,
consultant, and adviser.
Arrange educational meetings to ensure an understanding of the process and the expectations for it.
Do this at least twice during the process.
Make certain that interdepartmental relations are coordinated.
Departments cannot perform well without the cooperation of other departments. Make certain that
these interdependencies are properly documented.
Ensure that expenditures above a specific threshold amount that are included in the budget are
supported with proper documentation and financial analysis.
Incorporate into the budget procedure specific requirements covering approval for non budgeted
expenditures and cost overruns.
To sell the budget concept, select one department or profit center manager to convey the value of
developing an intelligent budget. Demonstrate how the budget has improved the performance of this
manager’s organization. The word will spread among the manager’s peers.
Express budget procedures in writing. Document corporate targets, policies, and constraints and
convey them to everyone who is involved in the process. Update this documentation frequently.
Provide each involved department with information on the department’s past financial and statistical
history, known economic factors, and the accounting chart of accounts in order to properly prepare the
department for effective participation. Classify the expenditures of individual departments care
Business fully. Do not arbitrarily allocate common costs to individual profit centers.
Budget product and service costs on a per-unit basis if possible.
Be realistic.
Do not create theoretical models that make accountability unachievable.
Prepare budgets that incorporate alternative environments and competitive factors. Have a fallback
plan available for emergencies; identify best- and worst-case scenarios. This enhances the thought
process.
Base the sales forecast on realistic expectations. Like all other budgets, it should be achievable, but a
challenge.
Establish production plans in accordance with a detailed forecast. Incorporate purchasing and
inventory strategies and product pricing expectations.
Incorporate the cash flow improvements from the capital expenditure budget into the operating budget.
These are interrelated parts of the planning process.
Develop and share the positive and negative elements of past budget efforts into the current process.
Learn from both the successes and the mistakes.
Make sure that reports of actual performance are provided to responsibility centers in a timely manner,
with the appropriate level of detail.
Never forget that a budget and its forecast components are estimates. Precision does not count.
Improve the quality and effectiveness of the process continuously.
Make sure that everyone knows that you are focusing on this issue. Solicit and accept feedback from
participants.

								
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