We have explored why it is important and essential for businesses to a budget. Now lets look at how time comes into the equation.
What is a budgeting timeframe?
The budgeting process for most large companies usually begins four to six months before the start of the financial year, while some may take an entire fiscal year to complete. Most organizations set budgets and undertake variance analysis on a monthly basis. Starting from the initial planning stage, the company goes through a series of stages to finally implement the budget. Common processes include communication within executive management, establishing objectives and targets, developing a detailed budget, compilation and revision of budget model, budget committee review, and approval.
Translating Strategy into Targets and Budgets
There are four dimensions to consider when translating high-level strategy, such as mission, vision, and goals, into budgets.
- Objectives are basically your goals, e.g., increasing the amount each customer spends at your retail store.
- Then, you develop one or more strategies to achieve your goals. The company can increase customer spending by expanding product offerings, sourcing new suppliers, promotion, etc.
- You need to track and evaluate the effectiveness of the strategies, using relevant measures. For example, you can measure the average weekly spending per customer and average price changes as inputs.
- Finally, you should set targets that you would like to reach by the end of a certain period. The targets should be quantifiable and time-based, such as an increase in the volume of sales or an increase in the number of products sold by a certain time.
| Objectives | Strategies | Measures | Targets |
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| What are you trying to achieve? | How are you going to achieve it? | What are the input and output measures? | Quantifiable and time-based |
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The terms ‘budget’ and ‘forecast’ are often substituted for each other, giving rise to the assumption that the two terms have the same meaning, although they actually have different, if related, functions.
It may help to think of a budget as a fixed representation of the goals and objectives of the business. An organisation prepares a budget as a plan of how they intend to operate over a certain period, and they use it to guide their decision making over that time. A forecast, by contrast, uses historical data to build a picture of what may happen in the future, if the planned budget is followed, which can be based on a varying number of scenarios. The forecast is therefore a useful tool to assess whether the business is moving in the right direction at any point during the budget period, by providing a point of reference for where the business expected to be.
Obviously, a budget is prepared using predictions and expectations of what the future holds: an effective plan takes into account factors that might affect the business’s ability to meet its goals and objectives. How-ever, budgets and forecasts operate independently of each other in terms of systems and purpose.
When looking at the budget, what does performance indicators look like?
These can include:
- Compliance dates for scheduled payments
- Profit and loss deadlines
- Reports for quarterly, half yearly or annual
Business objectives create guidelines that become the foundation for business planning such as:
- Profitability
- Productivity
- Growth
- Customer Service
- Employee Retention
- Core Values
Performance objectives can be seen as milestones to achieving goals. A business performance objective could be to:
- Increase revenue
- Increase profit margin
- Earning ROI
Planning involves the determination of goals and the means by which they are expected to be achieved.
This includes:
- Having a set of key performance areas with key performance indicators (KPIs).
- Using KPIs to define the overall outcomes such as customer service, productivity, quality.
- Measuring actual performance against the KPIs using SMART objectives
- Comparing the actual result with the planned performance to identify any gaps
- Using corrective action if there is variation in performance.
Responsibility Accounting
In order to achieve the goals of an organisation, there must be efficient systems and processes in place. This will include:
- Monitoring and reporting back to management.
- Implementing control procedures.
- Making evaluations and taking appropriate remedial action to rectify deviations.
Individual members of the various business units are responsible for different tasks and functions. Where individuals work together to achieve organisational goals, it is referred to as ‘goal congruence’. An accounting system that attempts to encourage goal congruence is called ‘responsibility accounting’.
Costs and revenue may be linked to an organisational chart which represents the responsibilities of the different sections or centres of the organisation, e.g. marketing, production, administration, quality management, sales, accounts, purchases, payroll, training and human resources.
In responsibility accounting, each division, branch or department is referred to as a ‘responsibility centre’. A responsibility centre is an organisational subunit, and the manager of each subunit is accountable for the activities and performance of that subunit.
The concept of responsibility accounting is that the person in charge has control over the operations and spending of a particular section and is accountable to others in the organisation for its performance.
The persons in charge of particular sections are only held accountable for the revenue or costs that are under their control, namely:
- Production or administration centre – The manager is accountable for costs only.
- Marketing or sales centre – The manager is accountable for revenue earned.
- Head office or chief financial officer – The manager is accountable for profit. This will include both revenue and costs.
- Board of directors, chief executive officer – Held accountable for profit and capital investment.
‘Controlling’ is the process of setting standards, measuring current performance, making comparisons and then taking appropriate remedial action as required. It is normal for an organisation to compare actual results with budgets by preparing performance reports. Reports need to be relevant and timely and set out in an appropriate format, so deviations can be readily identified.
Business performance is generally defined as the quantitatively or qualitatively measured input and output of an activity or a series of activities and can be considered from two perspectives:
- 1 Effectiveness assesses the progress of the business towards achieving its objectives.
- 2 Efficiency is the way in which the business maximises use of its resource to achieve its objectives.
Performance indicators are represented by measurable statements which are then used by the business to evaluate its performance. Key performance indicators (KPIs) are, as they imply, key to the objectives of the business.
A performance indicator does exactly what you’d expect from its name: it gives an indication of the significance of any variances that were revealed in the analysis. It needs to be measurable, and it should relate in some way to the objectives of the business. A performance indicator is what is known as a lagging figure as it is focused on past performance rather than looking towards the future; leading figures tend to be goals, targets or outcomes as they are forward focused.
There are two main types of performance indicators used, as follows:
- Financial indicators are found in the accounting records and are expressed in dollar terms.
- Non-financial indicators are commonly expressed in real terms and often make use of qualitative data.
Performance indicators are used to analyse the performance of specific areas within the operations of the business and can include:
- comparing figures within one year – for example, expressing gross profit as a percentage of sales
- comparing figures from different years – for example, comparing 2014 sales figures to 2015 sales figures.
The process of comparing the business’s results with those of similar businesses is also called benchmarking, which we will consider in more detail at the end of this chapter.
The types of analysis that are made with this information can include:
- whether the business is performing as planned
- whether its performance has improved over time
- how its performance compares to that of similar businesses.
Financial Performance Indicators
Financial performance indicators generally focus on profit. They are sometimes called ‘financial performance ratios’ since they can be expressed as a relationship between net profit (or gross profit) and sales, or between net profit (or gross profit) and cost of sales. The net profit is also referred to as the return.
Examples of relationships of profits are:
- percentage of net profit to sales
- percentage of gross profit to sales
- percentage of net profit to cost of goods sold
- percentage of gross profit to cost of goods sold.
Other financial performance indicators include:
- Market share: the percentage of the company’s sales to the total sales of all competitors (including the company) in a state or country, or an area within these
- Return on capital investment: the percentage of net profit to the capital invested in the organisation or profit centre
- Sales to investment: the sales generated by a dollar of investment
- Collection period or accounts receivable turnover: the average number of days taken to collect accounts receivable
- Inventory turnover: the number of times the inventory is replenished on average per annum.
Non-financial Performance Indicators
Non-financial performance indicators are not measured directly and the indicator that is chosen will depend on the area that the business needs to focus on.
The following are some examples of the types of non-financial performance indicators that can be implemented:
- Customer complaints: the number of complaints received from customers as a percentage of the total number of customers served
- Defective units: the number of defective units as a percentage of the total number of units produced
- Employee turnover: the number of employees who have left the business as a percentage of the total employees
Some businesses have products that only sell well at specific times of the year – for example, if you manufacture sunscreen, you’ll find that sales peak in summertime, and if you’re in the business of snow gear or run a ski resort, the logical trend would be a jump in sales when the weather cools. Similarly, the busiest time for accountants is tax season, and for florists, it’s Valentine’s Day or Mother’s Day.
What is a seasonal period?
Seasonal movements represent fluctuations that repeat each year. Seasonal effects on data will create variations that can impact on the outcomes of a business.
Using historical data of previous records will provide insight as to whether a business is affected by factors such as seasonal changes or holiday and events occurring annually.
Seasonal periods can be:
- Monthly
- Quarterly
- Annual
This can include breaking down the annual budget into seasonal periods for:
- Rent payments
- Lease payments
- Utilities
- Tax
- Insurance
- Inventory and supplies
- Payroll
- Loans
Factors that would need to be considered for seasons would be:
- Hiring staff
- Stock inventory
- Purchases
- Upgrades to IT
- Seasonal decorations
- Seasonal trades such as Easter, Valentines and Christmas
This can affect changes in:
- Employee wages (for example overtime during Christmas)
- Costs associated with hosting seasonal events
- Extra costs in postage and shipping
- Staff on leave
- Increases in petrol, transport or postage
Plan for the highs and lows
The first thing to do is to build a sales plan, broken down into months or even weeks, and by category, to get a good grip on exactly how much you sell, what you sell and when you sell it. This will allow you to identify the months of peak sales and those with the lowest sales, and to adjust stock accordingly to avoid overbuying. It’s a good idea to develop a sales and cash flow forecast as well.
Paying attention to market and consumer needs
Keeping an eye on market and consumer trends is important for a seasonal business as it allows you to market smarter according to consumer needs and wants in both low and high seasons. For instance, you’re a sunscreen retailer that typically sees a sales boom in summer, but you read that consumers are increasingly becoming more conscious of skin cancer risks, even in winter. A good marketing approach would be to capitalise on this trend – perhaps by sending out a customer email during low season reminding them of the benefits of SPF.
Trends can also be found within your own database – for instance, noticing that a specific product is especially popular with certain demographics such as young people or women can help you better target these groups.
These strategies will help assist you in identifying how to best create the budget effectively against the seasonally periods and align with organisational operating procedures.
