Budgeting in Business: How to Avoid Mistakes and Make it Work
You don’t need to be an expert or a professional accountant to do budgeting for your business. You only need to understand all your systems and processes and work out the best possible scenarios in your circumstances and use them as benchmarks.
Remember that budgets are only good if followed. Small businesses often develop budgets but lack the ability to implement them or to monitor them regularly. Analysis of the variance between the actual performance and the budgets has to be carried out on a monthly basis. Coordination and open communication is critical because if the need arises midway to change the budgets, all individual departments must work together.
Often times, the CEO/owner of the business changes the strategy but the staff in the various departments may not be fully informed and thus keep on adhering to the original budgets.
Why Do Businesses Fail Despite Budgeting?
Below are the key reasons why businesses today fail to thrive in spite of having budgets in place.
- Inability to adhere to budgets
- Fixed Budgets
- Unrealistic Targets
- Lack of Communication
- Ineffective action to variance between budgets and actual numbers.
Be smart and avoid these pitfalls to achieve financial stability in your business. The bottom line is that you need to ensure that your business is in a sound financial position to exploit opportunities for further growth. So do the right kind of planning by making precise assumptions and keeping a sharp eye on your performance. Success will surely follow.
How to make budgeting work
Integrating with the Strategic Plan
To successfully plan and coordinate the budget in the organization, it is essential to integrate the budgets with the organizational strategy. Strategy is the future of the organization and the budgets have to be drafted around them. To integrate strategy into the budgets, highlight your short-term (year-long) objectives first and understand them in operational terms.
For example, if you are running a small supermarket and you aim to be among the top few local stores, then you should translate this goal into numbers first. Estimate the sales in your budgets which should be realistic and then do your costing accordingly.
Linking financial & non-financial performance measures with budgets
One of the key benefits of budgeting is the control it provides over the performance of the business. The task of evaluation becomes much easier if the budgets incorporate what you are aiming for. Performance measurement has two dimensions, financial and non-financial, and both these should become an integral part of your monthly analysis of the company’s performance.
Traditionally, only financial performance indicators in terms of earnings, profits and other financial ratios were used to determine success and the ultimate goal was to maximize the bottom line profits. Financial measures are beyond any doubt crucial for your business; therefore develop benchmarks against which you can monitor your performance. These benchmarks can be obtained from data supported by past performance and industry averages.
For example, if you plan to achieve an operating margin of 20%, keep that in the forefront of your mind, while preparing the budget. You might have to decrease the unit cost of the products you sell and look for low cost suppliers to achieve your goal. Similarly, if you need a certain cash position at the end of a year, you will have to prepare your cash budget accordingly.
Increasingly ,performance management systems are also incorporating non-financial measures such as customer satisfaction, employee satisfaction, innovation, new product development, quality, social responsibility and intangible assets, like brand reputation, etc.
The senior members of the functional departments should all be part of the budget process. The objective is for your team to ‘own’ the budget. Once the sense of ownership is created, they are much more likely to strive towards the financial goals. Your staff might also see opportunities arising which you might not be aware of.
As emphasized earlier, the targets should have the flexibility to change according to the prevailing conditions and the circumstances. For example, if your company is not attaining its planned level of sales despite all your efforts, it makes more sense to revise the budget part way through the year, so that it is in line with the current realities. Another approach is to budget for various levels of activity.
For example, if you foresee your sales to be 1000 units per month then budget according to 800, 1000 and 1200 units, respectively. Then using your budgeting software or Excel spreadsheet change the output to get the required results. For a business to successfully implement the budget there has to be ownership across the board and the flexibility to adjust with the changing circumstances across the business spectrum.
Amer Qureshi, FCA is a highly experienced, finance and management professional with an excellent track record in senior management across several industries and in many countries. He is the principal contributor to Kamyabi.co.