Budgeting

Budgets are designed to carry out a number of functions within a business, such as planning, evaluating performance, co-ordinating activities and in larger companies, communicating,motivating and authorising actions. For a business to maintain control it needs
budgeting6 to produce annual budgets that can then be monitored against actual performance.

There are three components to a budget – namely the Profit and Loss, Balance sheet and Cash flow statements.

This page outlines the approach to be taken in preparing the company budgets – simply click on the links below if you wish to skip to a particular section.

Profit And Loss Statement – Sales

This will set out the expected sales for each month of the next year. The sales budget should be based upon expected sales volume and prices. A single sales line can be predicted but it can be prepared using more detail such as by product line or by customer (or a combination of the two). If the business is vat registered, vat exclusive prices should be used.

The key questions are:

What sales are you confident of achieving?
Are there firm orders or contracts?
Are there key customers that the business can rely on?
Are there seasonal variations to the sales pattern?
Does the business have the capacity to meet increasing demand?

Expenditure

Once the Sales budget has been agreed, the costs of the business need to ascertained.

Firstly, determine the fixed costs within the business i.e. those which must be paid no matter what sales are made. Examples are:

Rent, rates and insurance
Bank charges
Interest payments on loans
Electricity, gas and water rates
Advertising costs
Wages, Salaries and expenses
Administration costs such as accountancy

Variable costs i.e. those that will be incurred in line with the volume of sales. Examples are:

Material costs
Distribution costs
Overtime costs

By separating out the fixed and variable costs the business can calculate the break even position for sales. The calculation is:

£Breakeven = £Fixed Costs / (£ Sales – £Variable costs)

Balance Sheet Statement

This provides the effect on the businesses assets and liabilities of meeting the profit and loss forecast.

The basic format is:

Fixed Assets including computer equipment, machinery, office furniture and equipment, motor vehicles.
Current Assets including stock, debtors, cash and bank balances
Current Liabilities which contain trade creditors, and other creditors (or money owed ) such as paye/ni, vat, bank overdrafts etc
Long term liabilities which include loans from providers such as banks

Cash Flow Statement

The cash flow statement uses data from the two previous statements.

The important areas to predict are:

When will the money generated from sales actually arrive? Will there be any allowances for bad debts?
When will the business pay out for costs such as salaries, equipment and raw materials
Some payments are made in advance such as insurance and rent and rates or by monthly standing orders.
Other payments to be made such as paye/ni, vat, tax payments and loan repayments
What other money may be received such as loans or grant payments.

Planning

By drawing up a budget the business can spot potential problems before they happen.

Is the business in danger of underperforming?
Does the business need to build up sales volumes more rapidly or increase selling prices
Are the forecast costs too high and are there areas where costs can be cut back?
Does the cash budget show that the business will require an overdraft or will it exceed a current overdraft?

In what areas can the business improve its cash flow?

Can payments to suppliers be delayed or would this have adverse effects such as loss of discounts or damage good relationships with suppliers?
Can any planned capital expenditure be delayed or obtained using a finance option
Can alternative sources of finance be found such as agreeing an overdraft facility, invoice discounting, asset financing or agreeing a term loan?

Is the business in danger of overtrading?

The higher sales grow, the more cash the business will need to finance raw materials and wages.
If the level of sales increases substantially in a short time span the business may simply run out of cash to pay for more materials.
Without being able to obtain new finance the business would have to manage demand by increasing prices or rationing supply.
There is no point in gaining large orders, often at reduced prices, if as a result the business runs out of cash and goes into liquidation.

Control And Monitoring

By analysing actual results against the budget, the business can maintain control over its business.

Sales

Was turnover lower than budget and if so why?

Was sales volume down?
Did some customers receive larger volume discounts?
Will subsequent months turnover be similar?

If turnover was higher than budget what was the cause of this?

Sales prices higher?
Sales volumes higher?
If volumes were higher, has this been achieved by pulling forward future demand or is the demand higher than expected?
Was the increase achieved by a ‘one off’ large order?
Were sales of any individual product lines significantly different from the budget and what were the reasons behind it?Are some products becoming outdated?
Are there other more competitive products coming on to the market?
Is there a need to focus on or improve the marketing and promotion of certain products?

Costs

How do actual costs differ from the budget?
Are there any significant variances from the budget, either higher or lower?
Were these variances one off or will they be ongoing at the new level?
How has the variable costs compared with the budget – for example if a business expects to spend £1000 in material to produce 1000 widgets but it has spent £1100, has the price of raw materials increased by 10% or has the waste level increased by 10%?

Cash

How does the month end cash balance compare to the budget and what has caused the differences?

Has turnover changed substantially from the budget?
Are costs different? e.g. higher repairs and maintenance costs.
Did the timing of cash inflows or outflows differ substantially eg were there delays in customers paying and what were the cause of the delays (Was there problems in deliveries, incomplete or not on time, were there errors in invoicing, were there delays in invoicing etc)
Was there unforeseen capital expenditure e.g. a new machine was required for a specific contract to be undertaken?

Alpha Business Services have spent many years developing budgeting systems and producing management accounts. They can provide the expertise that a business needs to quickly produce budgets and forecasts.