A budget is an estimate of income and expenditure for a set period of time and can be used to:
- Ensure actual revenues and expenditures adhere closely to a financial plan
- Provide accountability for the people responsible for ensuring the budget is achieved
- Provide guidance and a sense of direction for a business
- Predict cash flow issues
- Model different paths or options a business may be considering
- Measure and reward performance
How do I prepare a budget?
- Decide on the general direction to be achieved within a budget
- Set timelines and constraints
- List the assumptions the budget will be based on
- Set forecasts for revenue, direct costs linked to the revenue forcast, overhead costs and capital costs. These can be based on historical data or from other sources.
- Keep a record of the details on what each figure in each forecast is based on
- Combine the forecasts into a cash-flow forecast and/or a profit or loss forecast for the period involved
- Include a forecast balance sheet if necessary
- Review and fine-tune the results with those who will be using the budget before finalising
How do I use a budget?
- Have regular reports on budget versus actual and investigate the reasons for any variances
- Set authorised expenditure levels that have been approved in the budget. Further authorisation is required for expenditure not budgeted for.
- Pay bonuses based on compliance within the budget
Once you’ve established a budget, you need to follow through with a review process, as this is the key to successfully achieving the budget’s objectives.
Client case study
In October 2013 new owners took over a run-down facility located in the city. With new management in place, they re-built the business. After an initial refurbishment program and six months into operations, it was decided that an operational budget was needed to keep a tight rein on finances.
The first budget was developed for the six months from 1 October 2014 to 31 March 2015, based on information from the first six months of operations. The budget was loaded into the accounting software and monthly reporting against budget started. It quickly became clear how important it was to segregate revenue and expenditure into cost codes that could be tracked and managed, and how the budget needed to be properly aligned with this in mind.
Each February, we sit with the manager to develop forecasts based on previous year actuals and set targets for the coming year. Every year revenue expectations have pushed upwards and costs are reviewed to try and reduce them downwards. The budget is fine-tuned in greater detail as our knowledge about the business grows.
In each full year that we’ve been using a budget in this way, the business has exceeded annual budgeted operating profit and management receive a bonus when this is achieved. The financial trends over the first few years have been remarkably consistent. Revenues have gradually increased, expenditure in most areas is constant and profits have increased as a result.