Setting a budget
Without a budget, there is a real danger that your business will overspend, or will fail to use its money to best advantage. Every budget has a limiting factor, usually the number of sales, though it could be shortage of working capital, lack of skilled labour, etc.
If sales is the limiting factor, your budget will be determined by the sales forecast as this is your estimated income. Many businesses find that sales have some seasonal variations, so you need to bear these in mind when estimating your expected income.
The basic budgeting process is:
Sales budget: Analysed by products, months, customers.
Operations budget: Labour, materials and other expenses to meet sales budget.
Accommodation budget: Rent, rates, heating, lighting, insurance etc.
Administration budget: Salaries, printing, stationery, postage, telephone, audit fees.
Selling and distribution budget: Advertising, packing, transport.
Finance costs budget: Depreciation, interest charges, bank charges, audit fees.
Master budget: Budgeted profit and loss account.
When you have your Master Budget (your Profit and Loss account) ask yourself:
- Does the profit forecast satisfy your needs/the needs of the owners?
- How does the Master Budget compare with last year?
- What return on capital does it provide?
- Does the budget look feasible, given current and expected trading conditions?
- Can more profit be obtained using a different strategy?
If you are not satisfied, check your figures and your forecasts. Could you do things a different way? What happens if you paint a 'worse case scenario' - would you get by?
Types of budget
Fixed or flexible:
A fixed budget stays the same all year, no matter what. A flexible budget is really a series of budgets for each time period, with each 'mini-budget' assuming different levels of trading activity. If your business is seasonal, a flexible budget may be best.
Zero base or incremental:
If your business is just about to start, you will need to prepare a Zero Base budget, which simply means that there is no history to base your budget on. A business that is up and running usually bases its budget on last year's figures, and is called an incremental budget.
Constant or inflated prices:
You can take inflation into account, or forget it and assume constant prices. If inflation is relatively stable and you are not in a business where prices fluctuate widely, assume a constant price.
A simple cash flow budget:
Budgets do not have to be complicated. You can keep a simple cash flow budget on a month-by-month basis, and use this to monitor your business.
An example of a simple monthly cash flow budget would probably look like this:
- Month = May
- Estimated bank balance at start of month = £23,000
- Expected income = £15,500 (from sales, debtor payments, borrowings etc.)
- Sub-total = £38,500
- Expected payments for month = £6,400 (salaries, creditor payments, rent etc.)
- Estimated bank balance at end of month = £32,100
You may find it easier to create a simple table to show these figures, as below:
Month Balance Income Sub-total Payments Balance
May 23,000 15,500 38,500 6,400 32,100
Monitoring your budget
Budgets are monitored by comparing your budget forecast with what actually happens - the difference between the two is known as the 'variance'. You show this variance for each item on your budget.
You can show the budget variance as a figure, or as a percentage, or both. The point is that the variance will alert you to possible problems. For some items, a small percentage variance may be significant, for other items, a large percentage variance may be no cause for alarm - it all depends on how much the percentage means in actual money, and on how much money it is. Only you can judge which variances are significant and which are not.
Once you have done that, you need to decide possible causes of the variation, and what you can do about it.
Managing your budget
Monitoring of your budget will spot any potential problems, but what do you do about them?
There are a number of options open to you if you spot variations between budgeted figures and actual figures. You can:
- Ignore the difference
- Balance an overspend in one area with an underspend in another
- Take specific actions to cut costs or stimulate sales.
Ignore the differences:
You may know what has caused the variance and not be too alarmed about it. Perhaps a large order has been held over until the following month. In this case, you may choose to ignore the variance.
Balancing overspend against underspend:
A simple way to cancel out differences, provided you have overspends and underspends that match well.
Specific actions:
These depend on what your business is and on your markets, but could include:
- Shopping around for more competitive suppliers
- Reducing hours
- Reducing staff
- Using part-time staff
- Sub-letting space
- Moving to smaller/cheaper premises
- Advertising more
- Using linked promotions
- Using special offers
- Using loyalty bonus schemes.
You may need to give some thought to your options, and choose the one, or mix, that seems right for you.
Revising your budget
You should revise your budget regularly - at least at the end of each quarter - in the light of what has happened to date. In this way, your budget will always reflect best knowledge and therefore be as accurate as possible.
If your business is seasonal, you may want to revise your budget more often than quarterly.
You may decide to revise your original budget, or simply make new forecasts for the year's outcomes.
All budgets are based on some assumptions, so it may be that you are not sure if the new assumptions will come about, or whether your original ideas are best. There is no need to discard your original budget.
When you monitor your revised budget, you can choose whether to compare the results coming in with the new, revised budget alone, or whether to compare the new results with the old budget and with the new, revised budget.