Business 101: How to budget the right way

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Business 101: How to budget the right way

Preparing a business budget can be a crap shoot. The reality is few budgets deliver to the cent.

After all, it is a forecast; the actuals can be very different. Sometimes, budget figures are way off. The mark of a good budget is how close it gets to the actuals.

There are several things resellers need to do to when preparing budgets.

Have a plan

The first, and most important thing, is to have a plan. A plan will help clarify whether the business is headed in the right direction and whether the market is growing as fast as expected. 

It also helps the business owner understand whether they have the right products and the right staff and, most importantly, whether the margins are correct.

A good plan helps the business understand what the competition is doing. It looks at staffing and employees’ skills profile and how that may change.

That outcome would have to be represented financially in the budget. The budget itself is just an outcome of those considerations.

The budget should also be a team effort.

Experts say the process becomes completely dysfunctional when it isn’t done by a team. The last thing any business owner wants is to have people in the organisation looking at the budget and saying: “What does this mean for me?”

It’s better to have them helping to build it so they know exactly what it means for them. 

So the budget process requires not only the input of the chief executive and managing director and their financial managers. Good budget processes take the views of various people working in operations.

That includes marketing and sales people. They are closer to the coal face and they are hearing what customers are saying.

Finance people can’t do it in isolation; budget preparation really needs to be a collaborative process. 

Preparing a budget takes time.

Most experts however warn you shouldn’t overdo it. Spending too long on it results in a law of diminishing returns.

Experts say two weeks should be sufficient for small to medium-sized enterprises. Others say spending a week over a two-month period is sufficient.

Some companies go off for a few days with key people to talk about what needs to go in the budget. Taking it outside of work creates a space for fuller discussion.

The process can take place over two days. The first is spent looking at blue sky and what the business strategy can do to improve the bottom line. The second day is spent looking at what’s actually achievable. 

Review your costs

The most important feature of the budget process is that it allows the company to review its costs.

Rather than look at last year’s costs and add CPI to then inform next year’s costs, experts say a better approach is to take time to consider them and perhaps go back to suppliers and negotiate.

Budget time is also when the business should be watching out for economies of scale and areas of duplication.

Budget specialists say top down/bottom up is the way to prepare the budget.

Top down and bottom up budgeting

The top down process starts with the managing director spelling out the business objectives for the next 12 months.

They might, for example, ask for a 5 to 10 percent increase in the size of the business over the coming year. Or they might want to look at ways of finding new markets.

This sets the strategic direction for the company’s budget process.

The bottom up process works in the other direction. People in operations work out their costs and do their forecasts.

The trick is combining the two.

Gather intelligence

The budget process also needs to involve intelligence gathering. Businesses need to know what competitors and customers are doing.

Once they have that information, they can determine where they should be focusing their budget efforts.

Some businesses go so far as to do scenario planning. This process creates a more robust budget which comes with built-in contingency plans.

Good scenario planning allows the business to identify trigger points as they go through the year. This helps the business owner develop and implement an “agility plan” when those forces come into being. 

The best managers now have three or four alternate strategies in their budgets, depending on how scenarios are panning out.

In a volatile market, this process can be as important as doing something about it.

Examples of potential scenarios might include contemplating the impact of the carbon tax on customers or, in anticipation of a Coalition government returning to office, a change in workplace legislation.

What happens, for example if revenues or worse still, margins, are out by 5 or 10 per cent? 

Good budgets give accurate but conservative projections of potential revenues.

They also provide accurate but conservative estimates of the costs.

And finally, they should have a contingency factored in just to cover unforeseen events.

Review it regularly

Finally, the budget needs to be reviewed regularly. Obvious areas are spending, revenue and working capital, including how much revenue is still on credit or tied up with debtors.

It’s also good to look at whether the monthly reporting aligns with the budget and forecasting.

It’s a good sign when there is not a lot of variation on a monthly basis between what was budgeted and the monthly figure.

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