Finance for Non-financial Managers

5. Budgeting

Annual financial statements are not enough to control your business. You also need to forecast what will happen, and to have up-to-date information on recent performance.

5.1 Prepare budgets to set financial targets and to determine financing requirements.

• You must produce a cashflow forecast.It is good practice to produce profit and balance sheet forecasts as well.
• Detailed budgets (eg sales and costs broken down for each product) allow you to see where your profits and cashflow are coming from.
• Your cashflow budget enables you to anticipate any financing requirements.

5.2 Create realistic budgets.

• While the previous year's figures provide a guide, forecasts must also take into account changes (eg new competition).
• Forecast monthly (or weekly) figures which take account of seasonal variations.
• Include timing effects (eg if customers pay 60 days after purchasing).
• Calculate a range of forecasts and the probability of achieving them.
• Computers can make budgeting and investigating what-if scenarios easier.For example, what the effect will be if your sales are ten per cent lower than forecast.

5.3 Compare actual performance against budgets to identify problems (and opportunities).

• Record actual outcomes and compare them to budgeted figures.It is easiest to see how significant the variances (ie differences) are if they are expressed as percentages.
• Identify the broad cause of the variance.This will be a different volume (eg sales of 1,100 against 1,000 budgeted), a different price or a combination of both.
• Regularly update budgets to take account of actual performance.

5.4 Be aware of real world problems.

• Imposing a budget (eg demanding cost cuts of ten per cent) often fails.Managers and employees are more likely to meet targets they have agreed.
• Budgets can build in assumptions rather than questioning them.
• Aggressively controlling performance against budgets can lead to managers setting comfortable budgets. These represent targets which are easy to meet, so that no one pushes themselves.
• Avoid setting over-ambitious and unrealistic budgets.