Sep 27, 2016

Budgeting is important for individuals and for business as well. Simply put, a budget is a list of prospective income and expenditure for a given period. It helps you in determining whether you can buy that bite you want to eat or should head home for a bowl of soup. It is typically created using a spreadsheet, and it provides a physical, organised, and easily understood breakdown of how much money you have coming in, and how much you are spending. It is an invaluable tool to help you prioritise your spending and manage your money, no matter how much or how little you have.

Whether you are a financial planner, a business manager or an individual, planning and monitoring your /your company/ your clients’ budget will help you identify wasteful expenditures, adapt quickly as the financial situation changes, and achieve the financial goals you desire. When you actually see the breakdown of all expenses, you may be surprised by what you find.

Creating a budget will decrease your stress levels because, with a budget, there should be no surprises. Budgeting is the process of creating a plan to spend your money. Creating this spending plan allows you to determine in advance whether you will have enough money to do the things you need to do or would like to do. Will you have unexpected car problems or medical bills? Do you want that dream vacation overseas? With a budget, you do not have to panic or wonder if you have the money. This sense of financial clarity is important not only in business, but throughout life.

The planning and monitoring of a budget or spending plan will keep you out of debt or help you work your way out of debt if you are currently in debt.

As an individual, extending your budget out into the future allows you to forecast how much money you will be able to save for important things like:

• Your vacation
• A new vehicle
• Your childrens education
• Your first home or home renovations
• An emergency savings account
• Your retirement

Using a realistic budget to forecast your spending for the year can really help you with your long-term financial planning. You can then make realistic assumptions about your annual income and expense and plan for long-term financial goals like starting your own business, buying an investment or recreation property or retiring.

As a manager, running a business often requires carefully planning and reviewing finances. Most companies use some form of accounting for identifying, measuring, analysing and reporting their financial information. Accounting tools may include budgeting, financial statements, forecasts and other tools for managing financial information. Business budgets are one of the most important accounting tools a company may use in their business operation.

Facts

Business budgets usually represent a detailed analysis of how a company expects to spend money in future time periods. Many companies create budgets on an annual basis so they can carefully outline the expected needs of each department in the business. Using an annual budget process also limits the amount of time companies spend creating and managing capital resources. Although larger companies may have employed accountants or other professionals to create the business budget, small business owners are usually responsible to complete this function themselves.

A major benefit to using a business budget is the ability to limit how much money is spent on certain operations. Budgets usually count expense accounts to ensure that capital is not wasted on unessential items or the company does not overpay for economic resources used in the business. Limiting the amount of capital spent by the business may require owners and managers to find new vendors or suppliers for acquiring business inputs, saving money and meeting budget limits.

Companies often use budgets to plan for future business growth and expansion. Capital saved on regular business expenditures may be placed into a special reserve account designated for selecting new business opportunities. Budgeting for future growth opportunities ensures that companies have capital on hand when needing to make quick decisions for expanding business operations. This capital may also be used during slow economic times as a safety net for paying regular business expenses.

The budgeting process is composed of creating a Master Budget. (See the figure below)

Master Budget

The budget process begins by estimating sales. The sales information is then provided to the different units to estimate the production and selling and administrative budgets. The production budgets are used to prepare the direct materials purchases, direct labour cost, and factory overhead cost budget. These three budgets are used to develop the cost of goods sold budget. Once these budgets together with the budget for administrative and selling expenses have been developed, the budget income statement can be prepared.

After the budgeted income statement has been developed, the budgeted balance sheet can be prepared. Two major budgets comprising the budgeted balance sheet are the cash budget and the capital expenditures budget.

Firstly, you need to know how many items/hours you must sell per month to reach your goal income. This is spread over a 12 month period. If you are currently not able to work out this part of how you will earn your goal income, then you are not setting your business up for success.

Truthfully, predicting a precise amount of sales or profits is nearly impossible due to a company's many products (with varying degrees of profitability), the company's many customers (with varying demands for service), and the interaction between price, promotion and the number of units sold.

In spite of these real-world complexities, company managers use a simple model or technique referred to break-even point or break-even analysis, to forecast the level of sales and to determine the sales needed to obtain a certain profit.

The break-even point is the point at which total expenses and total revenue are equal: no profit or loss. At the heart of break-even point or break-even analysis is the relationship between expenses and revenues. It is critical to know how expenses will change as sales increase or decrease. Some expenses will increase as sales increase (variable expenses), whereas some expenses will not change as sales increase or decrease (fixed expenses).

Variable Expenses

Variable expenses increase when sales increase. They also decrease when sales decrease.

Examples of variable expenses:

• Sales salaries commission
• Material
• Labour
• Machinery oil
• Phone usage
• Electricity consumed

Fixed Expenses

Fixed expenses do not increase when sales increase. Fixed expenses do not decrease when sales decrease. In other words, fixed expenses such as rent will not change when sales increase or decrease.

Examples of fixed expenses:

• Rent
• Depreciation
• Training
• Office expenses
• Managers’ salaries
• Insurance
• Fees
• Interest expense
• Phone line rental

A company only generates profits after all fixed costs for a period have been offset by sales.

For example, if a company has:

$700,000 fixed expenses

$200 Selling price per unit

$150 Variable expense per unit

Then the break-even point in units is calculated as:

= 2,667 units

So the company has to sell 2,667 units in order to break even. But companies’ managers do not want to only break even. They also want to earn a certain target profit.

Using the same example above, the break-even point with a $200,000 target profit is:

= 4,000 units

To find out the $ amount of sales multiply the number of units by the Selling price per unit:

4,000 units x $200 = $800,000

In conclusion, if a company manager wants to create the selling budget for the next month and he wants to make $200,000 profit, he needs to sell $800,000 worth of products or services. Similarly, he/she will budget for the following 11 months and thus developing a sales budget for the next 12 months.

For more information, visit our budgeting courses here.