HOW DO YOU DO A BUDGET?
No business should commence operation without a budget having been prepared. A budget is the business’s financial plan for the future. It outlines how the will use its resources to meet its goals. The budget contains projection of incomes and expenses over a set period of time.
The small business owner needs to predict the business’s financial needs at various points in time. Once the owner has determined the goals and objectives, they can then estimate the various costs the business will need to meet and the revenue it will receive. A profit budget will establish the viability of the business by predicting how much profit is likely to be made from expected sales. Although these figures are estimates – they must be realistic.
Regardless of the type of budget being prepared, it is important that the budgeting process remains flexible. Because budgets involve predictions of future events, they are not expected to be perfect.
Budgets are simply a tool for planning future events. As time passes, the budget plan should be reviewed and updated as required. Modifications should be made as more up to date information and figures become available.
Budgets provide information in quantitative terms (that is, as facts and figures) for planning and decision making and enable constant monitoring of progress in problem areas.
Budgets can be drawn up to show:
- Cash required for planned outlays for a particular period
- The cost of capital expenditure and associated expenses against expected revenue
- Estimated use and cost of raw materials or inventory
- Number and cost of labour hours required for production.
They provide financial information for specific goals of a business and are used in strategic, tactical and operational planning.
Budgets enable constant monitoring of objectives and whether they are being achieved. They assist in emphasising the corporate objectives of the business and provide a basis for administrative control, direction of sales efforts, production planning, control of stock, price setting, financial requirements, control of expenses and production cost control.
Budgets are used in both the planning and control of a business. As a control measure, planned performance can be measured against actual performance, enabling the business to take corrective action as needed.
In preparing a budget, various factors need to be considered, for example:
- Review of past figures and trends, and estimates gather from relevant departments in the business
- Potential market or market share, and trends and seasonal fluctuations in the market
- Proposed expansion or discontinuation of projects
- Proposals to alter price or quality of products
- Current orders and plant capacity
Considerations from the external environment (for example, financial trends, availability of materials and labour).
There are various types of budgets prepared and used by business each business will have requirements that vary to the next. A service business or retailer for example may not have production costs however the cash flow budget is common to all businesses.
This predicts future cash receipts and purchases and also revenue expected from business offered on a credit basis. Cash budgets operate on a set time frame (in the near future) e.g. monthly, quarterly, six monthly or yearly. It allows business owners to determine whether income will cover expenditure for the period. The longer the term of the budget the more difficult it becomes to predict with accuracy.
A cash budget will include a schedule of expected revenue from debtors and expected outgoings to creditors. This is called a ‘Schedule of Collections’.
A cash budget is also used to determine the need for outside funding. A budgeted cash flow statement will help highlight those times when a cash shortage is likely and therefore alert the business in advance. This allows the business an opportunity for action to bridge the period of shortfall. Whenever a cash surplus is likely, provide the business with opportunity to consider alternative investment options. This enables the most effective use of the resources of the business. If there is a projected shortfall then the business may stall outgoing monies, finance the shortfall or the investors may inject (invest) more cash.
If a cash budget predicts a cash surplus then the business can use this to finance new projects, ongoing business, reduce debt or invest the cash.
This predicts a business’s asset requirements for example equipment, land, buildings, vehicles and so on. The budget caters for upgrades or repairs to existing assets and allows for the purchase of new assets. The capital budget is a prediction of company needs in regard to fixed assets, such as buildings, vehicles, machinery, and other equipment. It includes the cost of upgrading present assets, the cost of acquiring new assets, costs associated with maintenance of the assets, and fees associated with the assets. From this a business can determine if they have enough cash to invest in the assets required or whether they need to find outside sources of finance.
This projects future sales that are broken down to products (product forecasts) and dollar values (sales forecasts).
This projects future advertising and other promotional requirements.
This is used by manufacturing companies and product producing entities it estimates the units required (to be produced) so that it matches the sales budget and the cost estimates for each unit.
This estimates all the costs associated with meeting budgeted sales targets (includes businesses such as service businesses or importers or resellers that don’t manufacture products but still have costs associated with the sales.)
Sometimes a business may be contracted to undertake a single one-off project. The business needs to predict the cost of the entire project from material, labour through to incidental expenses related to the project.
This combines all the other budgets formulated by a business. It outlines all the budgets plans in one budget. The master budget is a very detailed budget used to set out the plan of operations for an entire company. It is also used to produce a budgeted profit and loss statement and budgeted balance sheet.
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