Businesses don’t plan to fail – they often just fail to plan properly – if at all. The skill is knowing where to start and how to do it.
Unfortunately – the devil is in the detail!
For most companies, establishing a formal budgeting process within the organisation is key to its continued operations. It’s often a long drawn out process crunching the numbers, but it’s vital to achieving ultimate success (and avoid catastrophes).
The main content looks at the process adopted by larger companies – however this can be significantly trimmed down/edited to match the needs of smaller companies. In a small company (or for any business start-up idea) it can be summed up in four simple steps:
- How do you plan to do the sales? – determine the expected sales numbers and BEP (break-even point)
- Prepare a forecast profit and loss statement (based on the numbers)
- Calculate your Gross Margin
- Calculate your Net Margin
and providing the resulting numbers look good – go ahead!
In a larger organisations there are three stages in the twelve step process: Planning, Monitoring & Action
Planning
1. About three to four months before the current year-end, the Budget Office issues all available information concerning top management policies and plans for the future to the various controllers and managers, and initiates the planning for the coming year.
2. The Sales MD with the aid of market surveys, trend and statistical studies, forecasts sales in physical units and value.
3. These are studied by the Production MD and, assuming they have the production capacity available, they forecast the quantities of materials and labour hours and probable production overheads to produce the forecast volume.
If the present capacity is too small or if there are other limiting factors such as materials shortage or specialist labour shortage, then urgent high-level discussions must be held to resolve the difficulties or to adjust the budget for sales.
With the aid of financial and cost information, the production controller produces the estimated cost of achieving the proposed sales budget together with the cost of producing items for stock.
4. Forecasts of selling and distribution overhead and administrative and occupancy overhead, and financial overhead are made by the departmental heads concerned based on the forecast activity.
5. All the above forecasts are embodied in a master budget to show the net operating profit from the proposed activity.
6. The budget officer interlocks the various budgets so as to disclose the budgeted:
(i) closing bank balance;
(ii) closing materials stock balance;
(iii) closing finished stock balance;
(iv) closing debtors balance;
(v) closing fixed assets;
(vi) closing creditors balance.
The forecast Balance Sheet is drawn up and the important operating ratios and Balance Sheet ratios are calculated.
7. If the budgeted Profit and Loss and Balance Sheet are not acceptable, alternative proposals must be prepared.
Monitoring
8. When the overall forecast is acceptable to the Board, it is broken down into short-term periods of, say, one month, and then issued to the controllers and managers as firm budgets for the coming year.
9. As soon as the year starts, sales, production costs and overheads are recorded with the same detail as was contained by the budgets.
10. At short intervals, usually monthly, actual results are compared with the budgets and:
(a) reported to top management, with
(b) sectional reports to the appropriate departmental heads and section leaders.
11. The reports should show:
a. actual results for the period and cumulatively to-date
b. budgeted results
c. variance (differences) from the budgets
d. explanations for all important deviations from budgets
e. as an additional yardstick for comparison, last year’s cumulative actual results up to the same date
f. comments and suggestions
Action
12. As a result of the above reporting, actions authorised by management are implemented with a view to:
a. exploiting favourable deviations from the budgets; and
b. minimising the effects of unfavourable deviations.
The above system of control is generally referred to as the ‘budgetary control process’.
