The operating budget is an essential tool for the management of a company. Indeed, it allows, among other things, to address the concerns of the banker, test different scenarios and manage its human and financial resources. However, to be truly effective, it must be prepared methodically and strategically.
Conditions for success
First, the budget should be planned according to the vision, strategic plan and objectives of management. For example, if a Quebec company wants to conquer the rest of Canada’s market, the budget must reflect this ambition and not only include sales expectations in Quebec. Then, the related objectives must be ambitious and stir people into action. Indeed, one might tend to underestimate the budget by saying that they will be able to manage it and to win the banker’s favor. However, a realistic budget demonstrates not only the seriousness of the business, but also the quality of management: the vision of the entrepreneur and his ability to anticipate things and plan and set goals (realistic but ambitious).
Ensuring to communicate the objectives related to the budget is also an important factor for success. Concerning sales, for example, a seller may direct its work according to the objectives. It is also a great way to mobilize the team and empower every person concerning the elements under their control. Finally, for the budget to be a really effective tool, it will be necessary to plan it before the beginning of the year, to be sure to have only one official version and to be sure that it does not present too many details and that it is flexible during the year in the event that an interesting opportunity arises.
The usefulness of the budget also lies in the way of conceiving it. A good methodology to establish the budget consists in:
Using projected sales as a basis
In the case of a company that is in its second year of operation, it is possible to rely on sales of the previous year, including the expected growth and inflation. For a start-up company, it is an estimate. In both cases, the estimates may be based on facts such as signed contracts, the volume of potential customers to approach, workforce hiring to come, purchase of equipment, premises, etc.
Preparing the budget as the internal financial statements
Adopting the same structure for the budget as that of the financial statements facilitates the comparison of the data, the measurement of the differences and then, subsequently, the decision making.
Gathering and properly documenting the assumptions
The assumptions are used for explaining the amounts included in the budget. They involve sales and expenses. For each of these aspects, assumptions are made taking into account the different elements.
They allow to track the overall growth of the sales figure. Sales include:
- Projected sales by product or service or territory,
- Business volume by customer.
They reflect a good knowledge of the cost structure and help plan the resources needed to achieve the projected sales. It is necessary to examine historical data in order to establish them. Expenses include:
- Factory overhead,
- Selling expenses,
- Administrative expenses,
- Financial expenses based on debts,
In general, the assumptions can be made on a monthly basis to reflect cyclical or seasonal activities, or they can be divided by 12, which is standard practice in the case of a start-up company.
If you are to prepare a budget for your business and want to get advice from a professional, do not hesitate to contact us. Our team will be happy to guide you through the process.