Do you operate in a vacuum? That is you run your business hoping all will go well. Unfortunately, without good planning a business cannot go too far. One tool business owners can use in planning is the budget. A budget helps a business owner plan to measure how effective the business is in reaching its strategic goals. A budget has three major goals:
- Planning: A business with a plan of action is more likely to take action than one without a plan.
- Creating consistency within all aspects of the business:
A budget turns an operating plan into actionable numbers. In other words, it brings consistency to all areas of operations. For example, if you plan to start a new product line a budget will force you to examine where the cash is going to come from. A budget also forces the business owner to allocate resources to major expenditures. In short, a budget keeps a business owners from living in the clouds and planning for reality.
- Evaluating performance:
Once a budget has been established, there has to be a system to measure and record the results. On a quarterly basis, the results from the budgeting process should be evaluated to determine if things are going according to plan.
Developing a good and useful budget
A good budget ensures all aspect of the business are considered before the final budget is approved. For this to happen, a business will need a master budget also known as a profit plan. The master budget begins with the sales forecast, then continues with the production budget and goes until the budgeted financial statements are created.
Sales forecast
The accuracy of the entire sales forecast depends on your getting this part of your budgeting process right. If you have been in business for a while, there should be some patterns that develop over time. If no patterns are developing, then the probability is you are not taking time to develop essential systems into your business so everything you do is random. When creating a sales forecast be sure to adjust for changes in the external environment.
Production budget
Once you know how much sales you expect, you have to think about how you will deliver on those sales. The production budget makes sure that you account for your labor, materials and overhead needs.
Selling and Administrative budget
Next you will need to create a budget of what it will cost you to sell the products you have made. Also included in this budget is the cost of administering your business.
Cash Budget
Once you know projected sales and what it will cost to make the sales, you put together a cash budget. A cash budget will show how cash will actually flow through the business which increases the likelihood of succeeding in the plans. It will be bad if you created a plan only to find out you do not enough cash to execute. With the cash budget, you know upfront if you need financing to complete the plan.
Income statement and Balance sheet statement
Lastly, create your projected income statement and balance sheet statement which will be used for measurement and comparison purposes.
In conclusion, a budget is important for planning for future growth. It allows for resource allocation and consistency within operations. Budgets serve as communication and resource allocation tools. It enables a business to control resources so it focuses on its core competencies.