Thomas Paine, the great revolutionary writer, is supposed to have said 'People don't plan to fail, they fail to plan.' His words of wisdom can certainly be applied to budgeting. Planning (together with foresight) is acknowledged as the best way to avoid financial problems. A well-planned budget helps you to collect and use information about the day-to-day functions of your business and to spot problems before they derail your business plan. Here are the steps to follow in developing your next budget...
1. See budgeting as a vital management tool.
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Your budget process consists of three main parts-forecasting revenue and expenditure, recording actual revenue and expenditure, and reporting and acting on variance between the two. Budgets usually evolve from business plans and, therefore, will change over time. Your first budget may be nothing more than a statement of targets. In subsequent years, with established benchmarks and an improving track record, you'll be able to make more accurate projections. Eventually, your budget will provide a detailed, accurate comparison of your actual and desired performance.
How to Prepare a Budget
2. Consider revenue and expenses separately.
Avoid trying to balance your receipts to expenditure in the first instance. Revenue is a product of your business plan and will have a 'lag' component-a start-up period before the cash starts flowing, anything from a couple of months to a couple of years, depending on your business. Expenses are your costs of resources and they will probably dominate in the early days.
3. Identify and list expenses.
The first step in costing your resources is to identify what those line items might be. A useful definition of a line item is one to which a monthly dollar value is assigned, such as office rental and rates, staffing wages and benefits, advertising, utilities such as telephone and electricity, vehicles, travel, legal costs... Many of these items are fixed expenses and this makes the task relatively straightforward. Begin by selecting broad headings and list in detail the line items or resources associated with each. Under 'Administration', for example, you might include stationery and office rental. Under 'Utilities' may be listed electricity and telephone.
4. Forecast revenue.
Revenue is sales. So, using your business plan as a guide, make projections regarding the sales you hope to generate. Those projections will represent a target and should be broken down into monthly and weekly components-the smallest possible denominator, the better. Don't ignore historical data when setting those targets; and consider factors like the economy, inflation, whether your industry is growing, and any new technology that may improve productivity.
5. Prepare working papers.
Working papers are detailed calculations-cash-flow projections- that provide the monthly figures budgeted for each line item of revenue and expenditure. Produce separate working papers for each line item in the budget; this may be as simple as month-by-month predictions of revenue to be generated from one aspect of your business. Jottings may accompany individual papers as attachments. When a review of your budget is called for, your working papers will be a valuable source of information. For example, you may find that your revenue calculations were unreasonable and thus were contributing to a budget shortfall.
6. Check for variance.
Variance between your budget and your actuals must be identified and acted on regularly. Ensure that the person responsible for maintaining the financial records is provided with a clearly documented list of individual components designated as line items. Using such information, this bookkeeper can logically record the actual transaction that can then be compared with the budget. Any variance, positive or negative, between actual and budgeted, is highlighted in a budget action list for follow-up action.
7. Prepare a budget action list.
A budget action list is a result of the comparison (usually at month's end) of the actual versus the budget. Note any variance on the budget action list leading to a reassessment of the budget workings, to an amendment of the recording of actuals, or to action so as to address any variance.
8. Prepare a budget report.
A written budget report is a 'hands-on' summary, prepared on a monthly basis, setting out major variance between actual and budget items. The report should account for any variance and recommend relevant actions. The report is forwarded to the boss or nominee who will either confirm the actions recommended or suggest alternatives. 'What action is needed?', 'Who will take it?', 'When is it completed?' These are the outcomes of this reporting and review process.
9. Use your budget to measure performance.
If you base your budget on your business plan, you will be creating a financial action plan. This can serve several useful functions, particularly if you review your budgets regularly as part of your annual planning cycle. Your budget can serve as:
o an indicator of the costs and revenues linked to each of your activities,
o a way of providing information and supporting management decisions throughout the year,
o a means of monitoring and controlling your business, particularly if you analyze the differences between your actual and budgeted income.
10. Use your budget to help finance your business.
Potential investors or lenders will want to know how they are going to be repaid, and that's where your budget can help. Your budget gives you credibility, shows how your business is traveling, conveys the type of business needs you have to meet, and identifies the resources you must have to be competitive.
How to Prepare a Budget
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