Budget, Budgeting and Evaluation

A budget is a financial plan that sets out, using figures, an organisation's expected costs, revenue and resources for a given period of time, usually a year. Small business owners may run their businesses in a relaxed way and may not see the need for a budget. However, if you are planning to still be in business in the future, you will need to fund your plans. Budgeting is the most effective way to control your cashflow, allowing you to invest in new opportunities at the appropriate time. Many small businesses have one overall operating budget which sets out how much money is needed to run the business over the coming period - usually a year. As your business grows, your total operating budget is likely to be made up of several individual budgets such as your marketing or sales budgets.

Benefits of a Business Budget

There are a number of benefits of drawing up a business budget, including being able to:
  • Manage your money effectively
  • Allocate appropriate resources to projects
  • Meet the organization’s objectives
  • Improve decision-making
  • Identify problems before they occur - such as the need to raise finance or cash flow difficulties
  • Plan for the future
  • Increase staff motivation
  • Monitor performance

Evaluation of Performance

Budgets are a valuable tool for evaluating the performance of a company at the end of the time period that the budget covers. Owners should look at actual expenses, for example, as compared to budgeted, or planned expenditures. By doing this, the owner can see how much actual expenses varied from planned expenses in order to improve the budgeting process in the next time period. The same is true for the revenue side of the equation. Owners want to see if planned revenue equaled actual revenue as this will help them plan revenue inputs for the future.

To boost your business' performance you need to understand and monitor the key "drivers" of your business - a driver is something that has a major impact on your business. There are many factors affecting every business' performance, so it is vital to focus on a handful of these and monitor them carefully. The three key drivers for most businesses are:

  • sales
  • costs
  • working capital
Instead of seeing budgeting as a grueling task, try to see it as a plan to bring the pieces of the puzzle that is your firm together. If you try to follow your budget, making allowances for changes, your time management will be much easier and your business life will be much more stress-free.

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Business Development and Strategy

Budgeting forms the baseline for a company's future performance. Managers create the budget anticipating financial conditions and market expectations for future periods. These managers calculate revenues and expenses for the period being budgeted. When the period reflected in the budget arrives, the managers compare actual expenses to the budget numbers and evaluate the department's performance.

Create Budget

Creating a company budget involves every department within the organization. The sales department anticipates market conditions and estimates future revenues to create a sales budget. The production department uses this information to create a production budget anticipating material, labour and overhead costs. Administrative and selling managers anticipate their expenses for the upcoming year. A budget manager coordinates the communication between each department and compiles each section into a master budget and creates budgeted financial reports.

Measure Actual Results

The accounting department records monthly transactions in the general ledger. The accountant creates regular financial statements to communicate the financial results for the company. The accountant also creates financial reports which communicate sales activity and department expenses for individual departments. The accountant distributes the department reports to the appropriate department managers and the complete set to the budget manager.

Calculate Budget Variance

The budget manager compares the actual sales and expenses to the budgeted sales and expenses. The difference between the actual and budgeted amounts equals the budget variance. The budget manager combines the actual numbers, the budget numbers and the budget variance numbers on one report for each department. The budget manager distributes this report to the department managers and their superiors.

Evaluate Performance

Budget variances are used to evaluate the performance of individual department managers. The larger the variance, the more questions superiors ask regarding the amounts. The department managers must explain the reason for the budget variance. If the budget manager has a reasonable explanation or the situation was out of their control, their performance is not adversely affected. If the budget variance exists due to mismanagement by the department manager, the manager's evaluation will be negative.