Happy reading and profiting from it.
|Publisher:||Partridge Publishing Singapore|
|Product dimensions:||5.50(w) x 8.50(h) x 0.23(d)|
Read an Excerpt
WHAT IS BUDGETING?
These are exciting times with technology and globalization affecting businesses from all corners of the world. In fact, globalization and technology has made it possible for the small businesses and start-ups to compete with giants of the industry. While it might encourage the business person or entrepreneur to go with the times and throw caution to the wind, it must be said that without good business practices and sound financial management, they will fail where others might succeed. Budgeting is a tool that helps businesses avoid such predicaments and is a useful survival tool for businesses. This brings us to the question of what exactly is a budget. The simplest definition of a budget is that it is an estimate of revenue and expenditure for any given period of time. It has also been defined as an estimate of costs, revenues, and resources over a specified period, reflecting a reading of future financial conditions and goals1. Therefore if follows that budgeting is the process of preparing a budget. In essence budgeting is a series of activities performed in order to prepare a budget which is a quantitative plan used as a tool for enumerating planned business activities in quantifiable terms over a given period of time.
1.1 Budgets as Part of the Business Plan
Plans are essential to any human activities to ensure that such activities are carried out efficiently and effectively. Planning is the process of coming out with a plan that lays out general objective and processes of any endeavour. Planning is defined by Merriam-Webster as the act or process of making or carrying out plans; specifically: the establishment of goals, policies, and procedures for a social or economic unit. In business, plans established to guide the business for long term sustainability or prefeasibility. Business plans are documents which are normally prepared by top management in any organization stating the goals of the organization and the methods and policies to be used in achieving the goals. Business Plans are long term (3-5 years) in nature and if done for the entire organization.
Budgets on the other hand are for a more specific period of time; usually for a 1 year period. A Budget articulates the business plan in details by providing a blueprint of all the activities and its attendant revenue and expenditure for a specific time period. Budgets are usually prepared by taking into consideration the goals, strategies and policies enshrined in the business plan. Budgets should help organizations achieve long term corporate goals. For example; a business plan for a company may specify a goal of achieving $100 million in sales within a five year period. If after 4 years the revenues accumulated amounts to $ 80 million then the budget for the 5th year must include activities and expenditures that will allow the organization to hit $20 million or more in the 5th year.
Food for thought
Does your company or the place you work at have a business plan and yearly budgets? If not, why?
1.2 What Exactly Are Budgets In Business?
A budget is a financial blueprint of a business in respect to planned activities in a specific period of time which is usually a year. Sometimes it is referred to as the yearly budget or annual budget. It is a plan of action in monetary terms that is compiled from departmental or functional budgets for the given period. This includes budgets prepared by various departments as follows;
Budgeted Cost of Goods sold
Production Quantity and Mix budget
Cash Budget of Cash flow budgets
Manufacturing cost budgets
Operating Expenses or OPEX budgets
We will deal more with the various kinds of budgets in later chapters but for now it is pertinent to note that in order to prepare a good budget the compiled "master Budget" must full reflect the aggregate sum of all individual budgets and no departments or functions in the organization must be left out.
The final deliverables in the budgeting process is usually in the form of a budgeted income statement, a budgeted cash flow statement and budgeted balance sheet. There are also collectively known as pro-forma financial statements or budgeted financial statements. Once prepared and approved, the budgeted income statement and balance sheet are used for controlling the activities of the business in the specific budgeted period of time.
Food for thought
Are budgets for big organizations only? Could it be suitable for small personal businesses as well?
1.3 Business Plans, Budgets and Forecasts
While plans, budgets and forecast are similar management tools with the focus on the future, there are not exactly the same and differs in terms of planning horizon, substance, motivation and deliverables. Business Plans usually tend to come first as it defines the business in terms of what it wants to achieve and how it will achieve its goals. Business plans are typically used as a tool to raise funds from investors or banks and its planning horizon may be between 3 to 5 years or more. Details of the plans are normally at company level and on a year by year basis. Pro-forma financial statements created are usually for multiple years to highlight the yearly growth of the company. Business Plans are similar to Strategic plans although it normally has a shorter time frame and is prepared in more details.
On the other hand Budgets are detailed departmental or functional level plans for a specific period of time which is usually one year. Budgets are mostly expressed in financial terms and are used for monitoring of financial performance of the company and various departments during the financial year in question. Budgets may include the participation of all department and functional managers and requires a sustained period of efforts to prepared and agreed upon.
Forecasts are similar to budgets and are expressed in financial or quantitative terms. Forecast can be done on an ad hoc basis or at certain regular intervals (quarterly, half yearly) and is usually more accurate as it reflects the actual situation more closely. Forecast differ from budgets as it is a non-binding estimate of certain items such as sales forecast and market share while budgets are documents which figures are agreed upon by both management and individual department or functions for performance management purposes. Forecasts are sometimes used to determine if the budget is on track or if corrective actions are necessary.
It must not be forgotten that there is a cascading sequence to plans at various level. Budget objective must be aligned to and help achieve business objectives while business objectives must be aligned to and help achieve long term organizational goals. For example; the mission of a company might be to control 70% of the market share in the food delivery market in the long run. Business plans are then formulated which may state that the company will achieve 20-30% within the first 2 years and will grow 10% every year to achieve the long term market share objective. The budget then would need to ensure that the sales revenue grow by at least 10% per year in order to support the long term objectives.
Companies may also use terms such as Long term planning, mid-term planning and short term planning to mean strategic plans, business plans and budgets respectively.
Cascading goals is the process of translating goals from one level of the organization to the next to ensure alignment between the organization's strategy and individual employees' activities and goals.
Benefits of Cascading Goals
Cornerstone Performance helps employees and managers define expectations, develop goals, and align employee goals with the broader organizational objectives. It provides an overview of each individual's goals and how it contributes the overall business strategy – increasing transparency, making expectations clear, and engaging the workforce.
1.4 Are budgets only for large organizations?
Large organizations with multiple departments or sections require a high degree of co-ordination between staff of various departments and functions to operate efficiently. The benefits for doing budgets are a plenty for such organizations and we will discuss these benefits in section 2.2 later in this book. However, that does not mean that budgeting as a process is irrelevant for smaller organizations or even one man operated businesses. We can do budget for any endeavours even with our own personal projects such as building a dream home or running a freelance service businesses. Some of the reasons why we do budgets;
To plan for the purchase of something of substantial value in the future like education fees, building a new house etc.
To monitor and control our income and expenditures
To help one control spending
Organizations big or small requires to a lesser or higher degree of complexity and effort when doing budgets but the principles and concepts that you are about to learn in this book applies to all budgets big or small.CHAPTER 2
THE IMPORTANCE OF BUDGETS FOR BUSINESSES
While we have learned earlier that budgets may never accurately reflect the future, it is nevertheless an important process for businesses as it provides the business a set of revenue and expenditure targets to base activities on and for monitoring performance as it happens. Actual performance can be compared with budgeted performance which will allow top management to take the necessary steps for adjustment but accuracy of budgets vis-a-vis the future is not as important as the agreed upon targets set which provides benchmarks for performance monitoring and appraisal that is acknowledge by both management and departmental heads. There are also other reasons which we will discuss below but it is important to note that since planning is an important part of the management functions of Planning, Organizing, Motivating and Controlling, budgeting as part of the planning function is indispensable to businesses.
Some questions to ask yourselves; if any the answer is no then it helps to do a budget, even a simple one if you are just a small business.
Do you know exactly which part of your business is profitable?
Do you know how much cash you will end up with at the end of the next financial period?
Are you aware of any inefficiency in your operations that can be eliminated?
Do you roughly know how much you will make in terms of profits in the coming year?
2.1 Why should businesses do budgets?
Budgets can be requested by management and prepared for many different situations in addition to the routine annual budgets. For example; a budget would need to be prepared before a department can start on a new major project where expenditure to be incurred is substantial. Budgets may also be required when large capital purchases are planned for.
For example; the setup of a new Production Line with new equipment and its requirement for more human resources will require a budget. An investment budget must be prepared to justify the additional line. The additional revenue from the production line must be higher than the incremental cost incurred and the depreciation expense from any of the new assets. Such surplus will normally have to be higher than the company's normal rate of return to be considered. Such budgets may be called capital budget or project based budgets and the main usefulness of such budgets is to ensure that the investment works and treasury can allocate the funds needed on a timely basis.
Food for thought
Although businesses use budgets for performance monitoring, the ultimate aim of the budget is to prevent cost overrun and provides a basis for decision making when situation changes. For example; when revenues drop by 20% against the budgeted sales, management will expect cost of goods sold to drop likewise against budgeted expenditure and operating cost should be tightened. In your opinion What are some of these cost which can be tightened?
For most businesses however, budgets are used as tools for organizations to monitor and review the performance of managers by comparing actual versus budgeted performance using financial measures such as gross margins, cost per item manufactured, overheads used and many other forms of measures. Figure 1 below illustrates how performance can be monitored using the relevant measures. For example; one way of monitoring profitability is to monitor the gross margins of the business against the budgeted gross margins. The review of this measure can be further analysed by reviewing relevant variables such as material cost per unit sold and average selling price of the products. All such measures can be compared against similar measures in the budget. That is provided the budgets are done in proper levels of details and are realistic while at same time challenging.
Management sometimes allow for variations in the budget due to the change of business environment caused by global economic situations or geopolitical considerations. The business environment in present times fluctuates frequently due to technological disruptions and other factors. For example; a company like Sapura Energy in Malaysia which operates in the oil & gas support industries has its share price and profitability reduced significantly in 2017/18 due to low energy prices due to a glut in the market caused by the advent of shale oil production in the US.
2.2 What are the Benefits of Doing Budgets?
There are many benefits of doing a budget but in the end, it really depends on what you wanted the budget to do in the first place. In some large companies top down management is practiced so the details and outcome of budgets are mostly an exercise with coming out with the detailed budgets that meets the profitability or other goals of management. For example; based on head office requirements of a 10% net profit, accountants and senior management of a manufacturing company may work out the details of how the company can target to achieve 10% net profit. In such instances the budget as a tool monitoring achievement of departmental managers might not really be a benefit to the organizations, since the end result is more important than the how. In most organizations however, especially those which are fairly autonomous, management can derive much benefits from doing budgeting. Such benefits can be derived from the use of the budget after it was prepared and also the process of preparing a budget.
a. As noted earlier in this chapter, budgets can be beneficial to top management as a tool to measuring performance of the organizations or at the departmental level of the same. Performance can be reviewed by comparing the actual results of the organization or department with their budgeted results.
b. Budgets are useful as it also forces all departments to prepare for actual work by identifying resources that are needed for day to day operations which might not be procured if a budget was not made.
c. The budgeting process is an excellent exercise in interdepartmental coordination and communication. It can help foster closer working relationship between departments and help improve interdepartmental communication. This is especially true if department heads are new and have not worked closely with other department heads before. In most companies, the sales manager and the production manager have contrastingly different goals; on one hand the sales manager's goal is to increase sales and the other hand the production manager is to produce the optimum amount, at acceptable quality at the best cost. When the company is not doing well, the sales manager may say that the low revenue was due to the production department inability to supply the right amount of goods. Such issues would not surface if the company have done a proper budget where by both managers have meet to discuss their respective targets and communicate to each other their respective limitations.
d. Budgets are also useful as roadmaps for managers throughout the year which can guide them when certain issue arises. For example; when production problem arises for a particular product the production manager can look at the current inventory of that particular product and the sales plan for the next few months so that he has some idea how long he has to fix the problem. He might also find that the product's planned sales figure are low for the next month and make the decision to produce other models first.
e. In large organizations like conglomerates or even the civil service, budgets are useful to as an authorization tool. It is impossible for the CEO or leader of such big organization to sign and authorise all payments for purchases in the organization since such items may be in the thousands every day. Budgets, which are properly prepared, can be used to empower department heads to approve expenditures as long as such expenditures have been approved and provided for in the budget. The CEO may only sign to authorise major expenditures such as purchase of production equipment, investments and other big ticket items. In essence, if an item is not budgeted for it would also not be procured, unless it is sanctioned by the CEO after some analysis have been carried out explaining why the expenditure is needed and why it was not planned.
While we acknowledge that there are benefits of doing budgets, there are also some costs and disadvantages involved. Budgeting, especially company-wide budgets, requires managers to allocate time for the purpose of budgeting which reduces their time for managing the operations.(Continues…)
Excerpted from "Effective Budgeting for Businesses Today"
Copyright © 2019 Shum Ying Loon.
Excerpted by permission of PartridgeSG.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
Table of Contents
About the Author, vi,
Picture Credits, xii,
List of Tables, xiii,
List of Figures, xiii,
1. WHAT IS BUDGETING?, 1,
2. THE IMPORTANCE OF BUDGETS FOR BUSINESSES, 9,
3. GETTING STARTED, 19,
4. BUDGETING CONSIDERATIONS, 42,
5. BUDGETING ISSUES & GOOD PRACTICES, 58,
6. MAKING THE BUDGETING PROCESS EASIER, 67,
7. THE FUTURE OF BUDGETING, 74,