Budgeting for 2020

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For some small to medium sized businesses the process of budgeting may seem to detract from the focus on core business activities. Other businesses may swear by budgets and have thorough systems in place to budget effectively each year.

What is the Purpose of a budget?

Business owner’s motivation to budget depends on what they perceive the purpose of the budget to be. There are a few ways (whether correct or not) in which budgets are viewed by business owners:

1. As motivational targets for future performance (Incorrect) – Management may use budgets as performance targets for future periods. This however can be dangerous as this will lead to budgets becoming unrealistic as desired sales figures expand and desired expense reduction is tightened as management lays out their ‘Goals’ in the form of a budget. Employees will become unmotivated if budgets seem unrealistic as they will be ‘Doomed to failure’ from the start.

2. As concrete figures of expected sales and expenses for the year (Incorrect) – Budgets should be altered as sales volume and economic factors change throughout the year E.g. If your costs are higher throughout the year, but this is only because you manufactured and sold more items than you originally intended than this is perfectly acceptable and may actually be a positive.

3. Expected allocation of resources based on estimated sales and company strategic goals (Correct) – Budgets are most effective when they are being used to enforce the strategic goals of the organization in a way that is realistic and flexible with changing conditions. Separate incentives plans should be created to reward staff for good performance compared to the budget and actual results should be monitored to detect future problems especially regarding cash-flow.

Static budget or flexible budget?

Whether you are a service-based business or manufacturing business – Static budgets will quickly become obsolete as you realize you are not able to predict the future as well as you thought. There is much value to be had in creating ‘Flexible budgets’ which show budgets based on different sales volumes and best / worst case scenarios.

Once activity level (sales) have been confirmed a budget can be ‘Flexed’ AKA adjusted to show expected expenses based on the new actual level of sales.

Variance Analysis

Once your budget has been adjusted for the sales volume it can then be compared to actual results. If actual expenditure exceeded expected expenditure this would be considered an unfavorable variance.

Variances can be caused by two factors - Price or efficiency. Example: was the unfavorable labor cost variance of $1,000 caused by the price of labor per hour being higher than expected? Or was the price of labor per hour actually cheaper than expected but due to inefficiency you had to hire additional labor hours? Price and efficiency variances can be found using the following formulas:

Price variance = (Actual amount x actual price) – (Actual amount x budget price)

Efficiency variance = (Actual quantity x budget price) – (Budgeted quantity of inputs allowed for actual quantity x budgeted price)

Benefits of budgeting

· Implement Strategy by allocating resources in a way that will align company operations with company strategic goals.

· Provide benchmarks which can be used to evaluate performance.

· Anticipate future production or financial problems.

· Establish a basis for managerial rewards.

· Motivate managers and employees with financial bonuses for exceeding planned objectives.

Disadvantages of budgeting

· Can be time consuming

· May cause lack of motivation if not done right

· May cause managers create low benchmarks in budgets in order to get rewarded for exceeding them.

If you need help with budgeting for your business you can contact CTK Accounting at ctkaccounting.com.au – Servicing Sydney, Wollongong and The Southern Highlands.

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