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.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.