I could not agree more with Dave Ramsey, the American businessman, author and motivational speaker who said that a budget is telling your money where to go instead of wondering where it went.
Some of you might recall my previous blog on the five reasons why we budget. I would now like to continue with part two, and flag the five major steps on how to compile a business budget.
Budgets do not have to be difficult but they have to be process-driven consisting of these five essential steps:
1. Establish a Target
When I start with a budget I like to relate the specific business to a golf course. I see the flags as income targets, and par per hole or par for the course as the estimate ideal costs. If you end up getting all the balls in the holes under par, you’re a champion.
2. Gather information
Let’s stay with the golf course analogy. During a budget process we have the freedom to move the flags and we can work out ways to better our game that we need less strokes.
In doing this we need historic information on operational and financial performance. We also need future indicators.
We might be able to move the flags further away (more income) and cut some strokes by getting more efficient, but unfortunately we cannot do much with changing the layout of the course.
There will always be obstacles such as water hazards, sandpits and rough terrain, or in a more practical sense, changes in demand or technology or competitors disrupting the market. Hence access to reliable external information is also extremely important.
3. Have a good template
This is where the hardcore number crunching comes in. Yes, tailored budget application software would be ideal, but most of us don’t have that luxury.
A well-laid out spreadsheet would be the next best thing, however, we are not all Excel gurus or have a spreadsheet geek in our midst.
My personal preference is to download a standard spreadsheet or out-farm a template design which is much easier than getting the specifications right. This has to be done by the budget team where a good understanding of the business and the environment it’s in is paramount.
4. Link cost drivers with resources
This could be quite technical, yet identifying and allocating the correct amount of resources for each main activity in the production process will result in accurate estimate gross profit per income units or income streams.
Imagine you manufacture two main products, running shoes and boxing gloves. These products are not only different in appearance but also in how they are assembled / produced, thus the activities involved vary. They would, however, share the same overheads such as factory rent, electricity, administration wages, etc. The overheads are relatively easy to factor in, and together with the gross margin per product (income minus direct cost per unit), and an idea where the estimate sales are heading you’ll soon be getting a comprehensive picture of the future financial stance of the business.
5. Communicate & Review
Communicating and reviewing the end result with the team and other stakeholders is obviously very important before the final submission. However, this step actually also needs to be part of each major activity throughout the process. It is essential that there be ultimate buy-in from all the team players and operations at any stage of the process. Communication is the key.
In the spirit of Gary Player, the South African golf legend:
“The more I practice the luckier I get.”
We should not be afraid to embark on challenging budget processes. We might not always stay clear of the rough or may have to dodge the water hazards at times, but perseverance will deliver great results and make the awesome recollections at the 19th hole priceless.
Johan Czanik has deep roots in cost accounting, marketing and business management. His ability to draw on his vast and diverse experience and assist in budget management will enhance the profitability of your enterprise.