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Reprinted From: Delaware Business Review
A budget is a fundamental tool to help you manage your business effectively. Most businesses make use of budgeting concepts. In some businesses, the budget may take the form of being extremely comprehensive and becoming an integral part of a strategic plan, or in some businesses, budgeting takes the form of limited planning and is not a part of an overall plan intended to create goals and objectives for management.

Budgeting in its simplest form could be an estimate of demand for a specific number of items to be resold in a specific period of time. A comprehensive budget might include such information as:

  • Balance sheet as of the end of current year and budgeted year.
  • Income statement for the current and budgeted year.
  • Analysis of cash flow.
  • Projected expenses by departments and/or categories compared to the prior year.
  • Budgeted capital expenditures.
  • All basic budgeting assumptions such as:
    • Personnel cost
    • Fixed overhead
    • Variable expenses
    • Sales units

The business that looks at budgeting from a comprehensive viewpoint will be much more likely to monitor its budget as compared to actual operating results. This business will have involved its important and key people in the process and will make appropriate personnel accountable for their various areas of responsibility.

The financial budget is not intended only to be a set of numbers projecting the results that a business might achieve during a period of time. The budget should be a flexible working tool that will serve management's objectives. Because management will be familiar with the underlying assumptions, they should be able to react quickly to changing conditions. This will allow them to adjust business decisions and maximize profitability. When a budget is constructed there is no way for management to have total control over internal nor external factors that will ultimately affect their projections.

It is management's adaptability that will clearly make a difference in their being able to alter flexible factors that may increase volume, maximize gross profit and control expense factors.

A budget is constructed by incorporating every possible assumption that can be made as to the operating and capital requirements of a business during the period covered by the budgeting process. It will be necessary to make both major and minor assumptions as to inflation, pricing of product or services, personnel related matters, as well as, capital spending assumptions.

In order to put together a budget it will be necessary to make assumptions regarding all revenue and expense factors. Those individuals in a company most familiar with certain aspects of the business will put together information required by those who are responsible for the overall budget.

After a budget is developed individuals in various departments should receive their respective parts of the budget so they have objectives from which to work. It would be hard to imagine a person responsible for sales and marketing not knowing what the company's budget is for the coming year. At the same time, those responsible for production or purchasing will need to have some idea as to the cost that can be incurred to produce the product going to the customer while allowing for a reasonable profit.

Someone needs to be responsible for monitoring the variable expenses that a business incurs. Fixed costs, such as rent, equipment lease expenses, insurance and other items that must be paid for regardless of activity levels need also be reviewed. Those expenses that vary based upon levels of activity must also be closely monitored by responsible individuals. Some expenses vary directly with output. Some expenses are semi-variable in nature and can be somewhat controlled.

A business which can quickly react is one that ultimately will maximize its profits. The budget should be compared periodically to actual results so that variances are analyzed. Each business must decide what are reasonable variances. The planning process must incorporate an understanding of ranges that could be expected and be acceptable. This understanding makes the comparison process a management tool that is of great value. Overall budgets should be reviewed on a monthly basis at a minimum.

Some portions of a budget and operations of a company can be reviewed on a daily basis. The more a budget is monitored the more likely it is to be able to react to ever-changing conditions. In the troubled times that a business operates in today, it is particularly important to be able to respond both to internal and external factors that affect the business.

Most businesses are finding that it is a struggle to be successful, profitable and perhaps even survive in today's economy. Many businesses have gone through a period where they often could outrun mistakes. The past decade was generally a good time for most businesses. Now conditions are most difficult at best. The business that will survive during this period of time will be one which can adapt and make change so as to be part of the business community when conditions improve.

Each business is different and needs different monitoring. As business conditions change, some businesses react to those changes quicker than others. That is true whether times are good or bad. It is also true whether a business is profitable or losing money.

Every business must create a budget, then monitor it by comparing actual results to the budget, make personnel accountable for their areas of responsibility and appropriate members of management must understand the budget and be prepared to react to those factors that will make a difference. Working with a budget will alert management to changing conditions from those anticipated and, therefore, decisions can be made to minimize negative results and maximize the positive, leading to increased profitability.