Godfrey Wasara Business Correspondent
Budgets and the budgeting process
2014 is coming to an end and by the Lord’s mercy; we might shortly be marching into 2015. Most business entities especially medium and large companies have formalised budgeting procedures and, once more it is that time of the year they are busy working on their financial plans for 2015.
Almost all businesses and individuals engage in some degree of financial planning.
In organisations the extent to which plans are formalised into written budgets vary from business to business.
I will always encourage every business entity to come up with a written budget which acts as a standard and a guide to operations and this month I am going to give you some guidelines in formulating your own business budget.
I will illustrate how large entities do it and from there you can customise the process to suit your operations.
Colleagues you will agree with me that business success hinges on serious financial planning. No matter how bad your financial plan might be, it is still a plan. A poor plan is better than no plan at all.
The ability to come up with business annual financial plans improves with practice. The more you do it the more realistic your plans will turn out to be and the easier it becomes to manage your business.
What is a budget?
A budget also referred to as a financial plan is a road map or a plan setting forth the route for achieving financial and operational goals of your business.
The plan is expressed in quantitative, usually monetary terms, covering a specified period of time usually a year.
The plan will set out among other things, the turnovers you anticipate to achieve, the cost of such turnovers, administrations and other operational expenses and the amount you will spend in acquiring assets that will enhance the generation of desired turnovers.
The budget is just a plan and, like all other plans it will remain a plan and not the actual thing on the ground. Nevertheless it provides a standard upon which you will measure the actual performance and where variances are too wide you will be required to take the necessary corrective action.
Budget Period
The budget period refers to the entity’s trading calendar which spans a year (12 months) not necessarily January to December.
The period can also be referred to as financial year. Most business entities have aligned the financial year to the calendar year to coincide with the government year for easy of accounting for taxes. So, if your trading or financial year coincides with the calendar year then you still have time to prepare you 2015 financial plans.
Budgeting Assumptions and parameters
As I have already alluded to, budgets are future course of action and, accordingly rely heavily on assumptions and parameters. An assumption is something you accept as true or will happen but however you do not have the necessary proof.
A parameter is a factor or limit which affects the way that something can be done or made.
When preparing budgets, assumptions and parameters are derived from macroeconomic indicators namely:
prevailing interest rates
foreign currency exchange rates
rate of inflation of deflation
the country’s anticipated gross domestic product
Political, technological and social factors
Such information is availed to the business entity by the CEO through the financial officer. The information is available from fiscal and monetary policy statements, the Central Statistical office and from scanning the environment.
Remember as an entrepreneur you must always be an insider looking out. So your budget will be prepared on the assumptions and within the parameters derived from the above.
The budgeting process and source of budget information
In large corporates, executive management acts as the steering committee. The financial officer co-ordinates the budgeting process and acts as a link between the preparers of budgets and executive management. S/he is responsible for issuing out the parameters, timetable and consolidating various budgets into one master budget.
Department heads are responsible for preparing departmental budgets in consultation with their subordinates to get their buy-in. Remember the whole process has to go the shop floor so that everyone in the organisation in made aware of the organisational goals and the part s/he has to play to achieve such goals.
Budgets can be zero based, incremental or continuous. Thus the budgets can be built from scratch, or use current information, performance and statistics as the starting point or continuous review of budget statements. Whatever method is adopted, should be defined in the budget policy statement.
Types of budgets:
The Revenue and expenditure budget
This budgets captures estimates of likely revenues for the period, estimated cost of such revenues; departmental costs ie administration, sales, workshop, human capital etc. Various revenue and cost centres budgets are consolidated into one master budget which shows an estimate of the profit the business entity is likely to earn by the end of the trading/financial year.
Capital Expenditure budget
These are estimates of costs to be incurred in the acquisitions of fixed assets that will enhance the revenue generation process. Fixed assets include land and buildings, property plant and equipment, office furniture and equipment, and IT equipment. All these are intended for business use and not for resale
Cash budget
The cash budget is a forecast of all cash inflows and outflows resulting from the above. All non-cash items will be taken out.
The cash budget is a strong management tool in that it warns you in advance when inflows will be less than outflows. You will then negotiate with your bank in advance to bridge the deficit.
Approval of the budget
Departments will agree upon their budgets, once this is done all are consolidated into a master budget that has to find buy in from executive management.
Once an internal consensus is reached, the budget is then forwarded to the board of directors as a proposal. The board will then approve or might not approve the budget. If it is not approved it is taken back for incorporation of board recommendations. Once it is approved it becomes official and is then rolled out as an official working document for the relevant year.
Budget implementation and monitoring
As I stated above, once the budget is approved by the board it becomes an official working document. Department heads are custodians of their budgets while executive management plays an oversight role. As they proceed with their tactical and operational activities they will have to put full reliance on their budget.
At the end of each month, management accounts are produced. Timing of such reports is of the essence if they are to remain relevant. The management accounts will among other things contain variance reports analysing actual revenue/expenditure against the budget, huge variances need to be explained and necessary action taken to remedy the situation.
Continue following your passion with determination.
Godfrey Wasara is a registered public accountant. He has passion for equipping people with financial literacy so that they can improve their living standards through enhanced appreciation of the best ways of conducting business and financial activities. You may contact him on wasaraman@gmail.com