Brief overview of budgets and how to set up operating budgets for personal or small business. Learn about different types of budgets, such as the zero-based and bottom-up strategies. Learn more at http://ryangroup.contentshelf.com/product?product=I130129000000BF4.in the full e-book version.
Hi. Welcome to Budgeting a necessary evil. My name is Teresa Jurgens-Kowal and I’ll be your host for this short training session. In this introductory course, we will discuss why we create budgets, different methodologies to build budgets, several different types of budgets (including the master budget, the production budget, and the capital budget. We will also talk about the important subject of monitoring and controlling actual expenditures compared to the budget.AnimationAdditional tools and tips to help you with budgeting are available in the e-workbook of the same title: A Necessary Evil, the Budget, at Get to the Point Books.com. The e-book comes with a downloadable and customizable e-Reader for just $12.95.Click on the link under the paper clip at the left to visit the Get to the Point Books website or you can click on the image of the book cover here to order our copy now.So, let’s get started first with some definitions.
AnimationA budget is a plan for the future, expressed qualitatively, usually in amounts of money, that covers a specific period of time, normally one year.AnimationThe word budget can carry a negative connotation, yet budgeting is an important component of successful businesses.Budgets are create for several purposes. First, we use the budgeting process to help clarify and solidify plans for the business. Second, we also use budgets for assessing how we are doing against the plan. And, finally, we use budgets to restrict or control discretionary spending. The last point is important if we are not bringing in as much revenue as we see outgoing in expenses. We’ll discuss more about controlling later on in this short course.
One of the primary reasons we create budgets is to help plan for the upcoming period. Planning for business and personal expenses can help us to better understand our strategic goals.The budget, in its planning function, serves as a roadmap for the expenses and is something like the GPS, or global positioning system, in your car. Once you program in where you want to go, the GPS tells you turn by turn how to arrive at that specific location. The GPS would be useless if you don’t have a final destination in mind.Similarly, the budget as a planning tool forces an in-depth conversation among the relevant parties about future plans. The discussion also allows the group to better understand which elements are required or needed without restriction, and which items are discretionary, or nice to have. For a family budget, paying the mortgage is a need that is required, while a vacation to Disney World would be fun but is a discretionary expense.
The second role a budget fills is assessment. Assessing allows the business to report on what has already occurred in the budget period, what objectives have been met, what goals are outstanding, and how much money is left to spend along with how much money is needed to cover upcoming expenses.If we consider our analogy with the GPS again, suppose we have programmed the device for a specific restaurant where we will meet friends for dinner. If the highway is jammed due to a traffic accident, we will assess that we need to change the plans, or make a mid-course correction.On the budget side, if the goals are not being met with current rates of expenditure, then we will need to add income, reduce expenses, or perhaps, change the timing of purchases. One of the benefits of the budget process is that if funds are running low in one month, but are expected to rebound in a future month, we can delay the purchase of some goods or services in order to not run out of money.
The third and final aspect of preparing a budget is to help monitor and control expenses. Businesses do not operate in a vacuum. Many people need to know about the financial state of the business. For example, if the business is requesting a loan to grow or expand operations, the bank will want to see a budget. Investors and stockholders also like to view budgets for similar purposes, especially if the business is involved in venture capital funding or going to an initial public offering, called an IPO.Other people interested in learning about a business’ budget include the board of directors, regulators, and employees. Each of these groups of people are vested in knowing what the goals of the business are and how much profit is expected from the business operations in the upcoming period.While the assessing function of the budget lets you know if you’re off course and how far, the controlling function of the budget allows management to identify corrective actions to maintain a balanced budget. Using our example of the GPS, we have already determined through assessment that the traffic jam will cause us to be late for dinner with friends. Using a controlling function, the GPS can reprogram a route on side streets that allows us to arrive at the restaurant in the shortest amount of time.
In addition to planning, assessing, and controlling, we create budgets to Animation1 – compel communications throughout all levels of an organization by a focuses discussion on the strategic goals and objectives.Animation2 – focus planning on the future rather than just day-to-day activities. One of the problems with running a business is that individuals can get wrapped up in keeping things running smoothly and meeting the immediate needs of customers and clients. The budgeting process allows management to take a step back and think about the long-term strategic plans for growth of the business.Animation3 – another role of the budget is to understand, identify, and address potential constraints. Suppose you have a child that is ready to attend college and you are also thinking about retirement. A constraint on your budget and future plans would be whether both events can be fully funded with a reduced income stream.AnimationFinally, number 4 – the budgeting process improves the coordination of functional activities across diverse departments and divisions. In very large companies, it is not unusual to find activities duplicated in different departments. A proposed budget can highlight the wasted effort and yield more efficient, stream-lined operations.
Other reasons for preparing budgets include:AnimationDefining and implementing standards of performance and excellence in the business. Lean manufacturing is one business process that recognizes and reduces waste. Recognizing components leading to cost-savings and efficiencies in one department can be shared and transferred to other departments by discussing the upcoming budget.AnimationA portion of implementing standards allows divisions and departments to benchmark with one another. Public organizations may benchmark their budget through third party services. Your children can benchmark their budgets against one another and learn about handling money as well.AnimationFinally, preparing, assessing, and controlling the budget can provide motivation for functional managers throughout the company. For example, the best practice sharing through standards and benchmarking offer inspiration for managers to implement cost-savings and efficiencies in their own departments.
There are two primary theories utilized to build a budget: top-down and bottom-up.AnimationThe top-down budget focuses on sales revenues first and then balances with costs. AnimationOn the other hand, the bottom-up budget first outlines all of the expected expenses for the coming period, then estimates a minimum required sales to balance the budget.It is important to be very detailed in documenting the expected costs – these are typically known with a higher degree of accuracy in advance than are sales. Additionally, it is easier to monitor and control expenses than it is to magically increase sales to balance a set of expected costs.
Additional techniques for creating a budget are the zero-based budget and the year-on-year budget.AnimationZero based budgeting starts with a clean sheet of paper. Using a bottom-up strategy, you will list all expected costs and estimated sales. The net difference between revenues and costs yield the anticipated profit (or loss).AnimationThe year-on-year budget will scale a prior years’ expenses and revenues by some factor to produce a current year budget. AnimationAs discussed previously, the difference between expected revenue and anticipated expenses yields the predicted profit or loss. Many new businesses need significant periods of time, one to three years, in order to turn a profit, so the expense budget is crucial to planning the operations.
However, even with a year-on-year budget, it is wise to create a zero-based budget occasionally, say every three to five years. Expenses sometimes become accepted costs of doing business when there might be a better way to streamline an activity. Additionally, when there are high levels of discretionary costs, such as legal or HR, it is prudent to evaluate the validity of such continued expenses.Note that you must use the zero-based budget for a new business or a new product. However, if you have an established business but have never created a budget previously, it is possible to estimate annual costs by factoring in expected inflation costs (check with the Bureau of Labor Statistics, for example). It is also possible to make an educated guess at sales revenue based upon prior actual sales, using volume and unit price data.
Two types of costs to include in the budget are the fixed costs and variable costs.AnimationFixed costs are recurring and known expense amounts, such as rent and leases, computer/internet charges, employee salary, wage, and benefits, and utilities.AnimationThe second type of costs to consider in your budget are the variable costs. These are expenses that can change based on the volume of production. For example, raw materials, packaging, and shipping costs change based upon the number of units produced in a given time period. Other variable costs change based upon business activity, such as advertising, travel, maintenance and repair, and taxes.
Depending on the type and maturity of the business, consistency of sales revenues and expenses, and the overall state of the economy, a company can choose a different monitoring and control frequency for the budget.Some common budget periods are annual, semi-annual, quarterly, monthly, weekly, or daily. For example, some very large projects are reviewed with a daily budget. Meanwhile, some government reporting requirements force monthly or quarterly budgetary reporting. Many individuals are paid every two weeks, so the family budget might use a two- or four-week frequency for their budget planning purposes.Linking your budget period to the reporting cycles and other fiscal periods can simplify many of the accounting tasks, as well.
So far, we’ve talked about how to build a budget – top down or bottom up. We’ve also discussed the budgeting basis – zero based or year on year. Next, we’ll address some specific types of budgets that businesses use to better manage their finances and achieve their goals and objectives.AnimationThe master budget is the collection of all anticipated business revenues and expenses across all divisions and functions, including future planning for capital expenditures.AnimationThe production budget, sometimes called an operating budget, will account for individual departments, functions, or programs. It will be composed of sales and expense budgets for each division or product line.
In particular, the sales budget for a division must include the following Sales forecasts (volume and unit pricing) Purchases Direct labor costs Manufacturing overhead, and selling and administrative costs.Be sure to include all costs required to manufacture or purchase products that are marketed and all costs to actually sell the product.Details of translating a production budget into a day-to-day operating budget can be found in Chapter 4 of the e-workbook, A Necessary Evil: The Budget published by Get to the Point Books. Remember you can get your own copy of this e-book by clicking on the first link under the paper clip at the left.
AnimationCapital appropriations involve major expenses for land and equipment. Note that you should consult a tax professional for specific definitions of capital for your business.AnimationThe capital budget is closely tied to the cash flow of the business. Decisions on active or upcoming projects should be made relative to the net present value and return on investment. You can learn more about these terms in a series of blog posts called Talking to Your Boss at the ChEnected web site. Click on the link under the paper clip at the left to access the Talking to Your Boss blog or click on the image on this slide to open the blog on finance topics.
AnimationAs we’ve been discussing the budget is the plan. You need to determine if planned expenses and revenues are on target for the upcoming period. You also need to compare actual expenses are in line with the plan. If revenues are too low, you can control money flow by delaying investment or other discretionary expenses. Or, in the happy situation when sales are higher than anticipated, you can adjust the budget to increase advertising expenses or offering a discount to premium customers to build loyalty.AnimationThe most common technique to compare the budget with actual expenditures is called variance analysis. Variance analysis compares actual revenues and costs with the plan, or the budget, item by item. We’ll talk about how to use variance analysis to adjust the plan on the next slide.
Any variance of 5% or greater should be investigated. In this way, if the equipment production costs at the company are falling into discrepancy, you can recognize the cost and plan differential, allowing you to perform maintenance rather than having to replace the equipment down the road.Note that a positive sales variance means you have sold more items than you planned, while a positive expense variance means that you’ve spent more money than planned.
Let’s summarize the key learning points from this short training session on budgets. AnimationBudgets can be used for planning, assessing, and controlling.AnimationWe recommend creating a zero-based budget with a bottom-up strategy. When sales and expenses are established after the business operates for some time, it is sufficient to do a year-on-year budget with validation by the zero-based budget every 3 to 5 years.AnimationThe budget period should link to reporting periods and may include separate budgets used to manage the production and operation at the firm.
If you’d like to learn more,AnimationThere is a lot of information available on the internet for preparing personal or family budgets. You might check out the Financial Planning Association to help with a family budget, for example.AnimationMicrosoft Excel is a great tool to help create a budget. The link on the slide provides a sample budget example in Excel that you can use as a starting point.AnimationFinally, if you’d like to learn more about budgeting, we recommend reading the full e-book available from Get to the Point Books for only $12.95. Since we are limited on time in this mini-course, the e-book can give you additional examples and references to help build a budget.If you’d like more information on budgeting or other business management processes, please feel free to email me at info@globalnpsolutions.com or by telephone at 281-280-8717 in the United States.Thanks for participating in this training session on budgeting. Good luck in your future efforts!