Prepare budget

What is an effective budget?

• Participative
• Accurate
• Flexible
• Comprehensive
• Understandable
• Relevant
• Comparable

The Budgeting Process

Budgeting involves developing and implementing a plan for an organisation’s activities and comparing the plan against actual performance.

The activities involved in budgeting include:

• Estimating and forecasting
• Planning
• Preparation of the budget documents
• Distribution of budget documents and implementing the budget
• Review of budget expectations against actual performance

Benefits of Budgeting

Budgeting provides a systematic way of reviewing objectives, coordinating future activities and setting realistic targets. It is an effective management tool and benefits include:

• Providing a set of standards against which performance can be measured.
• Each staff member’s specific role is clearly defined and understood.
• Identifies potential trouble spots, e.g. cash flow shortages.
• Builds good relationships and develops morale in the workplace.
• Develops a system to provide regular feedback on performance.
• Identifies variances between budgets and actual results.

Limitations of Budgeting

The main limitations of budgeting are as follows:

• The budget is only as good as the assumptions or estimates on which it has been based. There is always uncertainty with predicting future events, and the quality of the estimates will be critical to the use of the budget as a control document.
• The budget process may be expensive initially and during its operation with respect to both monetary costs and staff time. Management will need to monitor the situation to ensure the benefits exceed the costs of installing a budgetary system.
• Preparation of the budget is no guarantee of success. Other factors include the performance of staff members and management, and the operating and economic environment.
• The budget must be delivered in a timely manner to the relevant people in order for appropriate action can be taken.
• Variances between budget and actual figures need to be identified and addressed, and improvements implemented in a timely manner.
• The targets should not be too challenging, e.g. setting high or unrealistic figures.

The budget process should be clearly communicated to all staff members and used as a motivating tool to boost morale and commitment in the organisation.

Budget may include:

• Estimates of income and expenses for a period
• An estimate of the financial position at the close of a period
• Plan of action to achieve estimates
• Provide comparisons of actual results with budget predictions
• Analysis and interpretation of deviations to assist in corrective action and improvement
• Provide a basis for making forecasts to guide decision making

Introduction to Budgeting (Managerial Accounting)

The activities involved in budgeting include:

1. Estimating and forecasting
2. Planning
3. Preparation of the budget documents
4. Distribution of budget documents and implementing the budget
5. Review of budget expectations against actual performance

Planning is an important activity in business. It involves understanding the business environment, knowing the strengths and weaknesses of the business and preparing for the future. Budgets are prepared to show estimations and forecasts of how the planned activities and changes in a business will impact on profitability and liquidity. Budgets are used by business owners and managers to help them with:

Planning
A budget is a written plan for future activities. People from all sections of a business develop their own budget and set targets and discuss how their section contributes to budget targets and overall business performance. Preparing a budget requires owners and managers to thank ahead, set goals and plan for their achievement.

Co-ordinating
To achieve budget goals all sections must work together. Business decisions are based in part on the budgets. Achieving budget targets in one section of the business will depend on other sections meeting their targets. For example:

• Sales Budget – impacts on purchases, production and stock levels.
• Production Budget – meet targets to have the stock to sell.
• Purchases– dependent on the Sales budget, purchase raw materials and/or stock so the production targets can be met.
• Capital Expenditure Budget – need to buy more non-current assets to enable production?
• Expense Budget – keep to targets for costs of sales, production and other operating costs.

Controlling

A Performance Report compares budget targets to actual results. Any major differences can be investigated and corrective action taken. A variance between budget and actual figures may be the result of:

• Poor management – action must be taken to improve efficiency.
• Invalid budget estimates – budget figures must be revised.
• Changes in economic circumstances – budgets must be revised to reflect economic conditions.

A budget reflects the strategic planning of a business. The targets in a budget guide business activities.

A business should:

• follow plans made in the budget
• compare what actually happens with what was planned to happen
• make changes along the way if needed – a budget should be a working document that can be revised if there are changes in the economy and the market.

Operational plan

• A company’s operational plan will outline the activities and targets, which the organisation will undertake in order to work towards achieving the aims and objectives set out in the strategic plan.
• It provides the framework for day-to-day operations.
• An operational plan covers a one-year period.

The organisation's budget should also link closely to the operational plan and managed throughout the year. Ensures that income and expenditure are on track and meets targets and financial commitments.

Forecasting

The aim of the forecasting process is to produce an estimate of the quantities and values of all the products or services that a firm is expected to produce and/or sell in a future period.

The process may be based on:

• Market potential - The maximum possible sales under ideal conditions if all avenues are pursued.
• Sales forecast - The number of sales estimated under the specific marketing plan of the firm given the firm’s production capacity.
• The forecasting process may be both costly and time-consuming, and organisations need to balance the cost of generating forecasts against the need to obtain more accurate results.

Forecasting techniques described may include:

• Time-series forecasting: A time series is a series of data points indexed (or listed or graphed) in chronological order. Most commonly, a time series is a sequence taken at successive equally spaced points in time. Therefore, time-series forecasting based on historical patterns in data observed over equally spaced time intervals. The assumption is that there is a recurring pattern in the data that will repeat in the future.
• Delphi technique: this type of forecasting involves a group of experts preparing and answering questions. Once the results of the first questionnaire are analysed, a second questionnaire is prepared based on the results of the first. This second questionnaire is then presented to the experts again and they are asked to re-evaluate their responses to the first questionnaire. This process continues until the researchers have a narrow shortlist of opinions relevant to the forecasting information required.
• Financial statements: Forecasting is completed using information from Financial Statements such as sales figures and costs from the previous two to three years and after excluding certain one-time costs. This forecasting methods is often used in relation to mergers and acquisitions, as well as in cases where a new company is forming, and statements are needed to request capital from investors.
• Cause-effect method: Forecasting using this method is based on assessing the cause-and-effect relationships of the variable with other relevant variables such as changes in consumers’ disposable incomes, the interest rate, the level of consumer confidence, and unemployment levels. This method uses past time series on many relevant variables to produce the forecast for the variable of interest.

Double entry bookkeeping

The basic principle of double entry bookkeeping is that there are must be matching debit and credit entries to record every transaction. Under the double‐entry bookkeeping system, the full value of each transaction is recorded on the debit side of one or more accounts and also on the credit side of one or more accounts.

Therefore, the combined debit balance of all accounts should always equal the combined credit balance of all accounts.

For example, if a business decided to purchase a new table for the kitchen that cost $800 the transaction would be entered as follows:

Account	Debit	Credit
Welsh Dresser Cabinet	$800
Cash		$800

Double entry bookkeeping explained simply

Statistical analysis

Key principles of validity and reliability

Validity in statistics is about accuracy and means that we can be certain that a financial measurement actually measures what it claims to measure. Therefore, financial data is accurate and informed conclusions can be drawn.

Reliability in statistics means that the financial methods and calculations we use consistently provides comparable results. We can be certain that a reliable measurement provides the same result every time it is used to calculate financial data.

An example to illustrate validity and reliability is a clock that has an alarm set for 7.00am every day. But the clock is 20 minutes fast. The clock is reliable because the alarm goes off consistently every morning but it is not valid as it is ringing at the wrong time, it is showing 7.00am when the time is 6.40am.

Variance analysis

Variance analysis explains the difference (or variance) between actual results and the budgeted targets. This usually involves breaking up a group of costs or income into smaller groups to see what the variance can be attributed to.

Variance analysis helps management respond to performance issues and to understand present costs, to control future costs, and to improve budget forecasts.

A variance might show:

• That actual results are better than the estimates in the budget (Favourable)
• That actual results are worse than the estimates in the budget (Unfavourable)

Budgeting tips for your business

Financial administration

Key areas that should be addressed in financial administration policies and procedures:

• Authorisations so that is clear which job roles can authorise financial transaction within the business
• Purchasing procedures in order to be able to determine when and how equipment and assets need to be purchased.
• Debt collection procedures in the event of customers defaulting on payments.
• Customer credit limits policies so that customers don’t go too far into debt without a payment plan in place or work being stopped.
• Petty cash procedures so that the upper limit of small business expenses is defined and so that procedures for the use of petty cash are in place.
• Use of business credit card policy so that it is clear who can use a business credit card and for what purposes.

Key features of organisational policies and procedures for financial administration in relation to operational budgeting:

• Financial administration policies and procedures should align with business goals and plans. Thus, if business goals are to expand into a certain area, budgets may be created focussing on the area of growth.
• Financial administration policies and procedures should be flexible to allow for a range of circumstances, as well as changing circumstances.
• Financial administration policies and procedures should be easily interpreted and understood by everyone.
• Financial administration policies and procedures should be written in a step by step style so that the order of procedures from beginning to end are followed.
• Financial administration policies and procedures should refer to other associated documents, for example, templates that are to be used for budgets or forecasts.

Budgets using Graphics

Data for budgets need to be presented in a format that is easily understood and appropriate. This is an integral part of the communication of financial information, and specifically budgeting and forecasting.

Data can be considered the input to the budgetary process with information as the output.

The formatting of a budget is the “look and feel” of that budget.

Sources of that data may include:

• Cash flow projections
• Fixed costs
• Variable costs
• Sales records and projections

There are various presentation methods and formats which are appropriate for presenting the budget and forecast data. These include:

• Tables
• Graphics
• Estimates and projections
• Calculations
• Explanatory notes

The use of graphics within budgets can be a useful way of uncovering and illustrating any trends in the data, such as:

Factors affecting revenue forecasting

Irrespective of whether qualitative or quantitative methods are used, there are controllable and uncontrollable internal and external factors which will impact on the assumptions on which the forecast is based.

Controllable factors may include:	Past sales levels for the firm Productive capacity Pricing policy Advertising and promotion policies Characteristics of the product Product mix The launch of new products Accounting policies Choice of customer or market segments
Uncontrollable factors include:	General economic trends Interest rates and inflation Public policy and government regulations Political conditions and global events Changing demographics Actions of competitors and new products Availability of supplies and supplier actions

Businesses typically use statistical analysis when forecasting and analysing trends in the market. Statistical analysis involves the collection of information needed by the business in order to report the trends. It follows the following principles:

• Describes the nature of the data to be analysed.
• Explores the relationship of the data to the sample population.
• Creates a model to show the relationship of the data to the sample population.
• Validates the model of the relationship between variables.
• Allows prediction of a situation or trend that are most likely to occur in the future, thus, guides future actions.

Organisational Aims and Forecast

The business planning process is a key attribute of a successful organisation, and is a major function of its effective management. The process of planning has three main stages: First, an organisation establishes its overall long-term goals and objectives (referred to as ‘strategic planning’), and from this develops medium-term strategies (‘tactical planning’) which become the focus of managers within the business. Tactical plans are then broken down further to formulate the day-to-day ‘operational plans’ of the business, a significant component of which is the annual budget.

As a short-term plan, budgets are more detailed than other parts of the business plan. They consider the means to attain goals and use quantitative data such as dollar values to estimate the future direction of the business. This data usually includes sales quantities, production units, inventory levels, number of personnel and financial ratios.

The first step of the planning process is the determination of the organisation’s guiding vision, mission and values, which clearly documents why the organisation exists and where it wants to go and the guiding principles that will direct the decisions that are made on the way there.

Some strategies that a business can implement and ensure the budget aligns with the organisational aims is through the development of:

• Mission Statement (Why do we exist)

  

• Vision Statement (What would success look like?)

  

• Value Statement (Who are we and what do we believe in?)

  

• Organisational Structure (How will we organise our resources to achieve our goals?)

  

Revenue forecasting

Four methods that can be used to forecast revenue:

Time-series forecasting

A time series is a series of data points indexed (or listed or graphed) in chronological order. Most commonly, a time series is a sequence taken at successive equally spaced points in time. Therefore, time-series forecasting based on historical patterns in data observed over equally spaced time intervals. The assumption is that there is a recurring pattern in the data that will repeat in the future.

Delphi technique

This type of forecasting involves a group of experts preparing and answering questions. Once the results of the first questionnaire are analysed, a second questionnaire is prepared based on the results of the first. This second questionnaire is then presented to the experts again and they are asked to re-evaluate their responses to the first questionnaire. This process continues until the researchers have a narrow shortlist of opinions relevant to the forecasting information required.

Financial statements

Forecasting is completed using information from Financial Statements such as sales figures and costs from the previous two to three years and after excluding certain one-time costs. If the economic conditions and customer demand are comparable to the past, the business is likely to have similar levels of income and expenses in the future. This forecasting method is often used in relation to mergers and acquisitions, as well as in cases where a new company is forming, and statements are needed to request capital from investors.

Cause-effect method

Forecasting using this method is based on assessing the cause-and-effect relationships of the variable with other relevant variables such as changes in consumers’ disposable incomes, the interest rate, the level of consumer confidence, and unemployment levels. This method uses past time series on many relevant variables to produce the forecast for the variable of interest.

The following are factors that can affect revenue:

• Seasonality
• Political and legal climate
• Price
• Market research
• Unpredictable movements
• Industry trends
• Product
• Competitors
• Economic trends

Additional factors that are included in the budgeting process include:

Sales budgets

Master Budget: Sales Budget

• Shows the estimate or expected sales of a business for a period of time
• Expressed in terms of sales units and dollar values
• The sales levels are required to achieve the business objectives
• Central to budget process

Sales budgets can be by:

• Product
• Period
• Area

Fees budgets:

• Prepared for a specific service provided
• Examples are engineers, architects, doctors (based on number of hours worked or income received from a service provided)

Operating budgets – non manufacturing

Operating budgets include:

• Purchases budget prepared by Product, Period, Area or combination of them all.
• Cost of Goods sold budget (estimated cost of purchase of goods expected to be sold)
• Capital budgeting (process used to evaluate investment opportunities)
• Expense budgets (for example marketing, admin, financial, individual expenses, service industry budget)
• Budgeted Income statement (estimate of net profit for a period)
• Budgeted balance sheet (reflecting net assets of all planned operations for a period)

Cash Budgets

Master budget: Cash Budget

A cash budget is defined as a document which sets out the estimated cash receipts and cash payments for a future period. The cash budget is an essential management tool for an organisation and is used to predict liquidity and as a control tool as an organisation is required to pay its debts when they fall due. A reliable flow of cash is essential to the survival of the organisation.

A cash budget will only incorporate those items that involve the actual flow of cash, e.g. receipts and payments. However, it is not restricted to revenue and expense items as it can also include capital items such as the purchase and sale of assets, payment of dividends, drawings, and repayment of loans. Any items that do not involve a flow of cash are excluded, e.g. depreciation, provision for doubtful debts, bad debts, gains or losses on the sale of non-current assets.

There are four (4) distinct areas of a cash budget:

Cash budgets forecast amounts expected to be received or paid out of the business bank account.

• Helps to forecast the ability to pay debts
• Predicts borrowing needs ahead of time
• Plans for investment of surplus funds

Cash budgets include sub-budgets such as:

• Cash receipts
• Cash payments
• Accounts Receivable Collections

Preparing a cash budget includes summarising expected receipts and payments. It includes:

• Opening Cash Balance + Receipts (= cash available)
• Cash Available – Payments (= closing cash balance)

It can also be set out as:

• Receipts – Payments (=surplus or deficit)
• Surplus or Deficit + Opening balance (=closing cash balance)

Variance analysis

Variance analysis is the investigation of the difference between actual and planned results.

This level of detailed variance analysis allows management to understand why fluctuations occur in its business, and what it can do to change the situation.

Examples of commonly derived variances in variance analysis:

• Purchase price variance
• Material price variance
• Labour rate variance
• Labour efficiency variance
• Material yield variance
• Fixed and variable overhead variance

Reasons why variance analysis may not be a useful tool:

• Steady production is assumed so variances only calculated after each month and so by the time the figures are sent back, it may be too late to do anything about the issues or the information is irrelevant.
• Variances may not give much information at a gross level. For example, if the labour efficiency variance is 50%, you would still have to drill down further to find out what happened, so it takes a long time to get usable information to management
• Standards used may be biased, as they are set by those with a vested interest.

Read this article for further information on budget variance.

Read this article for further information on variance analysis.

Budget variance:

This resource provides information on example budgets, including actual, budget and variances.

Part of the step in the budgeting process is to negotiate. Overall the budget process is:

• Plan the budget
• Prepare the budget
• Negotiate
• Agree
• Monitor

The Budgeting Process

The purpose of negotiation is to allocate resources according to the targets, objectives and goals of the organisation.

• The budget should be negotiated and not bargained
• Everyone should be working toward one goal (complying with organisational objectives)
• There should be room for compromise

The negotiation process requires planning and preparation, using a clear strategy and tactic. Approaching negotiations requires good communication skills and engagement.

Planning

• Have clear objectives set
• Develop contingencies
• Determine the needs of all stakeholders
• Rank and value issues and list any concessions
• Conduct research
• Do a cost benefit analysis
• Consult with relevant decision makers
• Prepare the negotiation
• Write a clear agenda
• Organise a meeting

How to create an effective action plan

How to write a business plan

What is a business plan?

A business plan describes your product or service, identifies who the customer is, explains why they need your product or service, and shows how you’ll make money from that opportunity.

Why write a business plan?

How you write a business plan will depend on what you need it to do. There are a couple of key jobs a business plan can have. It can:

• explain a business idea
• convince lenders or investors to put money behind that business idea

It doesn’t take a book to do the first job. You can write a business plan that’s short, to the point, and easy to update. That may be all you ever need. But if you’re going for funding, your business plan will need to be a good deal longer and more comprehensive.