Why is budgeting a necessary requirement for your business.October 7, 2019
Whatever strategy you choose for your brand, you may not forget how important it’s to draft and formulate an accurate and complete budget.The budget is defined as to establish a planned level of expenditures, usually at a detailed level.
The budget is equally important when you start a new business’ idea to build an effective strategy for your brand, to organize the economic and financial aspects of a project, and also to enable a company to control the money outflow and economic needs for a specific period or project. Therefore, it’s a fundamental tool in validation, constitution, and normal operations, in every type of company whether it’s a start-up or joint-stock company.
However, still in 2019, there are companies that don’t carry out the drawing up of the budget. According to a survey from Clutch 61% of small businesses didn’t have an official documented budget for 2018. This problem is more prevalent with businesses that have 1 to 10 employees as 74% in this group didn’t create an official budget.
This situation causes a lack of business planning and organization. If you would create a good business and maintain it, it’s fundamental to have an accurate planning. In this way, this work is based on the importance of budgeting process and it’ll give you the main notion to write a complete and efficient final budget.
Chapter 1: The importance of a short- and long-term vision
A well-done budget considers, in the same way, both the short and the long-term view.Brand planning is a fundamental think about the development of an efficient business, and so it’s important to give the right importance both at the short and at long-term planning.
The short planning ordinarily concerns the intended objectives that will be pursued in 1 year. The annual budget usually should be prepared during the two months preceding the fiscal year-end to allow ample time for enough information-gathering. It’s also important to do a quarter-to-quarter plan for control the business situation, in a shorter period of evolution. Utilizing a shorter reference period makes simpler for your management and supervisory bodies to notice eventual mistakes or deviations in certain situations previously estimated. Planning in the short term means to know exactly every time the characteristics of all business areas and developing targeted strategies to improve them. In this way, company features that can be easily changed in the short term are the employees’ job positions and their skills. Other problems that can be solved in the short-term are the conditions of immaterial assets or the quality issues of products or services. To solve these problems, management should constantly examine the business situation every month, or if it’s necessary more constantly, and face these problems. Short-term problem resolution allows you to face the long-term with a clearer business vision.
If during the short term the companies mainly aim to correct any bad decisions taken in the past or changed situations, in the long run, they try to reach the company’s general goals and solve permanently the problems. During the long term, the “research and development” area is important, in order to understand market trends and future strategic positioning. Planning for a long-term budget allows you to compete and to find your placement within the technological, social, political, economic and financial environment. During the drafting of the long-term budget, decisions are made as to any changes in the share capital, the main capital expenditures are examined, such as the purchase of equipment, any mergers or corporate divisions, etc. The long term is essential to understand the vision of your company in a given reference period. If you do things right and so short-term ideas and results are successful, your long-term planning will be based on these results to preserve achievements and to ensure continued progress.
Chapter 2: Four different plans present in the final budget
In the corporate scenario exist 4 different types of budget, one coordinated with the other, which are drafted at the level of the company as a whole. Each type of these budgets it’s necessary at the enterprise level and these will then flow into a final document that will be called the final budget. These types of budget are:
The investment budget: is the starting point of the budget because it doesn’t require additional input information. In the investment budget, purchases and sales of capital goods are expected to be made in the following period. These forecasts must consider the long-term objectives that the company intends to achieve.
The economic budget: in this budget significant accounting entries are revenues, costs, margins, profits. The purpose of the general economic budget is to predict what the income of the activity may be generally for an annual period.
The capital budget: is a preliminary balance sheet and refers to the closing date of the annual year (31/12). How each balance sheet highlights the extent and composition of the company’s equity at a certain date. In this type of budget is important to consider the variations of the fixed assets, current assets, permanent capital, and current liabilities.
The financial budget: it’s fundamental, with the financial budget, to ascertain the extent to which the company will be able to finance capital needs with the means produced internally. In this way, don’t miss to understand if your company will need external financing and to what extent.
The finantial budget can be substantially divided into two parts: the budget of the sources and uses and the cash budget. The cash budget allows you to highlight in detail the cash receipts and expenses for a specific period. This type of budget is usually composed of two fundamental elements. A first element concerns the income and cash outflows related to transactions already completed and a second element concerning the cash receipts and expenses related to budget operations.
The budget of sources and uses is equally important because, with it, the changes programmed in the net working capital structure are kept under control, between the beginning and the end of the budget period taken into consideration. For a correct financial management it’s important to forecast the correspondence between the financial profile of the sources and the uses, keeping in mind that the investments can be short term (working capital) and medium and/or long term, as the sources can be choices between short-term debts (current account openings, disposal of commercial effects, etc.) and medium and long-term debts (mortgages or loans) and net capital.
All these budgets are important in the same way for any type of company and converge in a
in a single final document.
In addition, to be a forecast document, able to note, for example, any deviations in sales or purchases in a given period, the budget has various functions. It mainly has a control and management function, so that the “trajectory” defined in the budget is followed even after disruptive events, to correct the deviations and return to the pre-established situation.
It also performs a function of motivating coordination because it is drawn up and formulated by coordinated parts.
The budget helps your company to plan the proposes and goals guidelines to the core business. Careful budget drawing up and planning will allow to check and identify with reasonable certainty the cost to will be, and at the same time the revenues to be achieved. In this way, it will be possible to draw up a document to complete the budget process which will be called to as the final budget.
Chapter 3: Four different ways to do the budgeting process.
Did you know that your company can choose between different types of methods for reaching own budget? Let’s explain the difference between them. The methods differ according to the ways in which the values are found and according to the business needs in that specific period. The different methods of how your company can do a budget are:
Incremental budgeting: the incremental budgeting has the main characteristic to takes last year’s actual figures and value, and then adding or subtracting a certain percentage to determine the budget of the current year. This method is the most widely used because the training process is the simplest one. However, it is probable that it leads to causes of inefficiency. For example, when the only objective in the budget concerns the increase all the values and a manager doesn’t try to improve other results such as cost reduction or increase of revenues. In this way, the simplicity of the method leads several times to pursue a single goal and not to consider so many micro-objects.
Value-proposition budgeting: Value proposition budgeting is really a mindset about making sure that everything that is included in the budget delivers value for the business. Value proposition budgeting aims to avoid unnecessary expenditures.
In value proposition budgeting you consider the following questions:
- Why is this amount included in the budget?
- Does the item create value for customers, staff, or other stakeholders?
- Does the value of the item outweigh its cost? If not, then is there another reason why the cost is justified?
Zero-based budgeting: the zero-based budget together with the incremental logic budget is the most used. It starts with the assumption that all budgets start with a value of zero, without considering the trends of previous periods. No expense is justified a priori, and all entries placed there must be justified in that specific period. The main objective of this type of budget is to avoid expenses that aren’t essential for the company in that particular period. It’s mostly used when the company’s objective is to contain costs during an economic crisis or when there is a large corporate restructuring that changes the way the managers in charge of preparing the budget work.
Activity-based budgeting: the activity-based budgeting is based on the top-down approach. The top-down approach formulates a general vision of business objectives and goes into details later. In this way, each added part can be redefined by specifying more details. In the activity-based budget, it’s important that the company first defines the activities (productive, commercial, research and development) that will be considered and computed in the project or in drawing up the annual budget, so then discover the costs and revenues associated with these activities included in the draft budget.
Chapter 4: Budget planning for a specific project.
The budget planning for a specific project, in design and in each sector, is a process that requests studies about: the market in which the company operates; the resources that will have to be used and those that will be produced; the period in which the project will be implemented and completed. The budget planning of a project is usually divided into 5 phases:
1) Estimate the economic availability;
2) List your fixed-costs;
3) List your variable-costs;
4) Updating of expenses;
5) Creation of the budget.
The economic availability for a project is decided considering the expenses made for a similar investment, the prior data on previous periods, the performance of the company in that specific period, and the economic return given by a single investment.
The successive step is to list the fixed and variable costs. The fixed costs are a cost that doesn’t change in relation to production volume, while variable costs are what vary/change depending on the company’s production volume. Typical examples of fixed costs are office and real estate rents, employees’ salaries and insurances.
There are also particular types of costs called semi-variable costs. The semi-variable costs are costs which behavior is partly influenced by the levels of production. Let me explain. A share of the cost appears however even in the absence of production while the other quota has a reason for being and varies only according to the output levels. Examples of semi-variable costs are the cost of electricity, some maintenance costs, and logistics costs. The variable costs of projects are mainly related to the purchase of raw materials, semi-finished and finished products. Then there are other variable costs such as utilities, commercial costs, and some administration costs.
So, the successive step is the update of the expenditures used and the resources used during the project. It allows the company to notice any errors or to make corrections able to direct the project towards a better and more efficient conclusion.
Then, the last step is to create the budget with all accounting entries used during the drafting of the project and to note their use in the economic, capital, financial and investment/financing aspects.
Chapter 5: The importance of budget monitoring.
Creating your budget is only one step about the budgeting process. You also need to keep an eye on how you are doing compared what you had planned, and to carry out a proper review at the end of the budgeting period.
Monitoring allows your project to be constantly under control and to notice efficiencies and inefficiencies. It’s important, that the management is updated on all the progress concerning the projects, so as to be able to intervene immediately with the relative adjustments and modifications. Monitoring must be a priority and not a secondary activity. The operational management of your company should know if the work was well done, and the results that will be found analyzing the progress of the budget. If this were not the case, the important thing is that you take the problem seriously and try to resolve it in the most suitable way with your management.
When things go wrong, make sure you agree on the corrective action you need to take, and you assign responsibilities accordingly. In fact, it’s just as wrong to take hasty decisions, able to change the budget, without carrying out a careful analysis of the effect of changes on business operations.
It should also be underlined that several times, the effects of a planned budget may not be manifested in the very short term. In this way, it’s important to link to the previous theme the importance of the connection between the short and long term, a link that must be oriented to an integrated and unique corporate vision. It’s certainly important to communicate to the team both the objectives achieved, and the failures attained with the budget. A team is more motivated to continue with the work if it knows that the goal, for example, was reached a month in advance. Similarly, a failure must be communicated in such a way as to disclose the real business situation and increase the efforts and commitments of your employees.
Chapter 6: The analysis of budget variances.
Once the budget period is coming to an end, it’s important for you to agree on a date immediately after the end of the budget to meet with the people concerned and discuss how the operations described within it were carried out.
The analysis of deviations, at the management level, is a fundamental part of the management control about your company and allows you to obtain precise estimates of the budget accounts linked to the objectives set in the budgeting phase.
The analysis of variances makes it possible to compare the forecast data, fixed during the budget phase, with the final values actually obtained. In this way, it’s important to study the reasons for the deviations and provide solutions on the aspects that have led to higher / lower costs or lower / higher revenues. Also, is fundamental to discuss the aspects defined in the budget, from the drawing up to the way in which the monitoring was done.
It may also be important to obtain opinions from those who are not directly involved in the revision project, such as a component of the financial department or a manager who does not have a primary role in the process. Among the major factors that could give rise to a deviation compared to the data present in the budget we have: the unplanned introduction of changes to products or processes; inefficiencies in the procedures and software used in drawing up the budget or during monitoring; evaluation errors.
The fundamental purpose of the analysis of the deviations is to note any differences between the budgeted values entered in the budget and the actual originated values. The goal is to make corrections so as to report the values in line with those desired. Once the review has been performed and lessons learned, it will be important to take responsibility for implementing these actions and testing them in the next budgeting procedure.
In conclusion, we want to highlight the importance of this fundamental control and management tool which is the budget. Whether you are at the head of a small company or a large company, you cannot help drafting a document that is so fundamental to managing and controlling the development of your business. Now all you need to do is ask yourself how the situation of your company is and, if you and your company need it, improve corporate control to get better the entire business management.