Brighton School of Business and Management May 2011 Student Newsletter
Personal & Career Development Tip of the Month
Without at least a basic knowledge and understanding of the importance – the critical role – of budgeting, no manager or specialist can contribute to the organisation successfully.
In addition, without this understanding it is almost certain that progression on to more senior positions and responsibilities will not be achievable – or will end in failure!
We, the BSBM tutor team, strongly recommend that you accept this message and build knowledge and understanding of budgeting and financial management into your professional development plans.
May Theme An Introduction to Budgeting
Following on from the advice given above, here are some articles that demonstrate, in no uncertain terms, how important budgeting is to the success of any organisation – at departmental levels, at middle management levels, and at corporate, strategic levels.
This month’s newsletter offers an insight into why budgeting is so critical to the success of organisations of all types and sizes, and to the managers and specialist within those organisations.
A budget is a plan to:
· control your finances
· ensure you can continue to fund your current commitments
· enable you to make confident financial decisions and meet your objectives
· ensure you have enough money for your future projects
It outlines what you will spend your money on and how that spending will be financed. However, it is not a forecast. A forecast is a prediction of the future whereas a budget is a planned outcome that your business wants to achieve.
Benefits of a business budget
There are a number of benefits of drawing up a business budget, including being better able to:
· manage your money effectively
· allocate appropriate resources to projects
· monitor performance
· meet your objectives
· improve decision-making
· identify problems before they occur – such as the need to raise finance
· plan for the future
· increase staff motivation
Creating a budget
Creating, monitoring and managing a budget is key to business success. It should help you allocate resources where they are needed, and should not be complicated. You simply need to work out what you are likely to earn and spend in the budget period.
Begin by asking these questions:
· What are the projected sales for the budget period? Be realistic – if you overestimate, it will cause you problems in the future.
· What are the direct costs of sales – ie costs of materials, components or subcontractors to make the product or supply the service?
· What are the fixed costs or overheads?
You should break down the fixed costs and overheads by type, eg:
· cost of premises, including rent or mortgage, business rates and service charges
· staff costs – eg pay, benefits, National Insurance
· utilities – eg heating, lighting, telephone or internet connection
· printing, postage and stationery
· vehicle expenses
· equipment costs
· advertising and promotion
· travel and subsistence expenses
· legal and professional costs, including insurance
Your business may have different types of expenses, and you may need to divide the budget by department. Don’t forget to add in how much you need to pay yourself, and include an allowance for tax.
Your business plan should help in establishing projected sales, cost of sales, fixed costs and overheads, so it would be worthwhile preparing this first.
Once you have figures for income and expenditure, you can work out how much money you’re making. You can look at your costs and work out ways to reduce them, as well as seeing if you are likely to have cash-flow problems, and giving yourself time to do something about them.
You should stick to your budget as far as possible, but review and revise it as needed. Successful businesses often have a rolling budget.
Key steps in drawing up a budget
There are a number of key steps you should follow to make sure your budgets and plans are as realistic and useful as possible.
Make time for budgeting
If you invest some time in creating a comprehensive and realistic budget, it will be easier to manage and ultimately more effective.
Use last year’s figures – but only as a guide
Collect historical information on sales and costs if they are available – these could give you a good indication of likely future sales and costs. It’s also essential to consider what your sales plans are, how your sales resources will be used and any changes in the competitive environment.
Create realistic budgets
Use historical information, your business plan and any changes in operations or priorities to budget for overheads and other fixed costs.
It’s useful to work out the relationship between variable costs and sales and then use your sales forecast to project variable costs. For example, if your unit costs reduce by 10 per cent for each additional 20 per cent of sales, how much will your unit costs decrease if you have a 33 per cent rise in sales?
Make sure your budgets contain enough information for you to easily monitor the key drivers of your business such as sales, costs and working capital. Accounting software can help you manage your accounts.
Involve the right people
It’s best to ask staff with financial responsibilities within the business to provide you with estimates of figures for your budget – for example, sales targets, production costs or specific project control. If you balance their estimates against your own, you will achieve a more realistic budget. This involvement will also give them greater commitment to meeting the budget.
What your budget should cover
You should first decide how many budgets you really need. 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.
What your budget will need to include
Projected cash-flow – your cash budget projects your future cash position on a month-by-month basis. Budgeting in this way is vital for small businesses as it can pinpoint any difficulties you might be having. It should be reviewed at least monthly.
Costs – typically, your business will have three kinds of costs:
· fixed costs – items such as rent, rates, salaries and financing costs
· variable costs – including raw materials and overtime
· one-off capital costs – for example, purchases of computer equipment or premises
To forecast your costs, it can help to look at last year’s records and contact your suppliers for quotes.
Revenues – sales or revenue forecasts are typically based on a combination of your sales history and how effective you expect your future efforts to be.
Using your sales and expenditure forecasts, you can prepare projected profits for the next 12 months. This will enable you to analyse your margins and other key ratios such as your return on investment.
Use your budget to measure performance
If you base your budget on your business plan, you will be creating a financial action plan. This can serve several useful functions, particularly if you review your budgets regularly as part of your annual planning cycle.
Your budget can serve as:
· an indicator of the costs and revenues linked to each of your activities
· a way of providing information and supporting management decisions throughout the year
· a means of monitoring and controlling your business, particularly if you analyse the differences between your actual and budgeted income
Comparing your budget year on year can be an excellent way of benchmarking your business’ performance – for example, you can compare your projected figures with previous years to measure your performance.
You can also compare your figures for projected margins and growth with those of other businesses in the same sector, or across different parts of your business.
Key performance indicators (KPIs)
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:
· working capital
Any trends towards cash-flow problems or falling profitability will show up in these figures when measured against your budgets and forecasts. They can help you spot problems early on if they are calculated on a consistent basis.
Review your budget regularly
To use your budgets effectively, you will need to review and revise them frequently. This is particularly true if your business is growing and you are planning to move into new areas.
Using up-to-date budgets enables you to be flexible and also lets you manage your cash-flow and identify what needs to be achieved in the next budgeting period.
Income and expenditure
There are two main areas to consider when reviewing your budget – income and expenditure.
Your actual income – each month, you should compare your actual income with your sales budget. To do this, you should:
· analyse the reasons for any shortfall – for example, lower sales volumes, flat markets and underperforming products
· consider the reasons for a particularly high turnover – for example, whether your targets were too low
· compare the timing of your income with your projections and check that they fit
Analysing these variations will help you to set future budgets more accurately and also allow you to take action where needed.
Your actual expenditure – regularly review your actual expenditure against your budget. This will help you to predict future costs with greater reliability. You should:
· look at how your fixed costs differed from your budget
· check that your variable costs were in line with your budget – normally variable costs adjust in line with your sales volume
· analyse any reasons for changes in the relationship between costs and turnover
· analyse any differences in the timing of your expenditure – for example, by checking suppliers’ payment terms
* from a series of articles at www.businesslink.gov.uk
Best Practices: Developing Budgets
A budget is a systematic method of allocating financial, physical, and human resources to achieve strategic goals. Companies develop budgets in order to monitor progress toward their goals, help control spending, and predict cash flow and profit.
The central challenge that budget developers face is mapping out the future, something that can never be done with perfect precision. The fast pace of technological change and the complexities of global competition make developing effective budgets both more difficult and more important.
Important benefits of improving the budgeting process include better companywide understanding of strategic goals, more coordinated support for those goals, and an improved ability to respond quickly to competition. A discussion of best practices used by leading companies to develop budgets follows.
Link budget development to corporate strategy.
Because the budget expresses how resources will be allocated and what measures will be used to evaluate progress, budget development is more effective when linked to overall corporate strategy. Linking the two gives all managers and employees a clearer understanding of strategic goals. This understanding, in turn, leads to greater support for goals, better coordination of tactics, and, ultimately, to stronger companywide performance.
But how is such a link created? Companies that apply best practices find that communication plays an important role. Top management must take the lead in developing and communicating strategic goals. But to develop those goals, top management needs information about customers, competitors, economic and technological change – information that must come from customer-contact and support units. Companies that establish effective channels for communication find it easier to set challenging yet achievable strategic goals.
Setting goals before budgeting begins makes it easier for budget developers at all levels. When this happens, budget developers create from the start budgets that support strategic goals and that, therefore, need fewer revisions. Budget development then becomes not only faster and less costly but also far less frustrating.
Design procedures that allocate resources strategically.
Within any company, competition for resources is inevitable. Every function and business unit needs funding for both capital and operating expenses – usually in excess of the actual resources available. This makes it critically important for companies to design procedures so that resources are allocated to support key strategies.
Best practice companies find that resource allocation is part science, part art. Fortunately, following certain best practices leads to better results. One such practice is coordinating the review of operating and capital budgets. Doing this gives managers insight into the ways in which changes in one budget affect the other. Another practice is to develop sophisticated measures for evaluating proposed budgets. The measures used tend to vary by industry, but most take into account the company’s weighted average cost of capital.
Many measures also assess the degree of risk involved in competing plans of action, the costs or advantages associated with deferring action, as well as factors such as expected developments in interest rates. By using such measures, and by using cross-functional teams to examine action plans, companies can better select plans whose benefits will produce desired results. Finally, by monitoring the results of allocation efforts, companies can refine and improve their procedures.
Tie incentives to performance measures other than meeting budget targets.
Many companies still evaluate managers primarily on how closely they hit budget targets. While this may seem logical, in reality this type of one-dimensional evaluation tempts managers to “win” by playing games with budget targets. Such game playing isn’t always in the company’s best interest.
At best practice companies, meeting budget targets is secondary to other performance measures. Such companies use a balanced set of performance measures to chart progress toward strategic goals, and use the same measures in their incentive programs. This reinforces the importance of key strategies and communicates what results will be rewarded.
At many companies, business unit managers are involved in identifying the measures that are most relevant for their operations. Typically, some measures are financial, while others track progress in other efforts. For example, an appropriate nonfinancial measure for one business unit may be product defect rate; for another, speed to market for new products. Once the measures are identified, higher-level management clarifies what targets each manager is expected to meet. Managers and employees receive training on the company’s incentive program so that they understand the reason behind the rewards.
Link cost management efforts to budgeting.
By linking cost management efforts to budgeting, companies improve the quality of information available for managers to use in developing their budgets. Accurate cost information is fundamental to budgeting. Companies that use accurate cost management techniques and provide budget developers with ready access to cost information improve both the accuracy and the speed of their budget process.
Standardizing the cost management system companywide is an important step in improving the link between cost management and budgeting. Many companies also have found activity-based costing (ABC) helpful in identifying the real cost of producing, selling, and delivering products and services. Even small- to medium-size companies are exploring the potential of ABC, as packaged software becomes more widely available and brings down the cost of engaging in this type of analysis.
Another best practice in linking cost management to budgeting is the strategic use of variance analysis. Variance analysis is the study of differences between budgeted and actual costs, or the study of costs at one company compared with industry averages. By using variance analysis to identify weaknesses, managers can identify areas where their organization needs to improve its performance. But managers must focus on those variances that have a significant impact. Otherwise, decision making and budgeting can become bogged down in trivial detail.
Reduce budget complexity and cycle time.
Best practice companies strive to reduce budget complexity and streamline budgeting procedures. Such streamlining allows management to collect budget information, make allocation decisions, and communicate final targets in less time, at lower cost, and with less disruption to the company’s core activities.
By controlling the number of budgets that are needed and by standardizing budgeting methods, companies take important steps toward streamlining budgeting. Another key step is to minimize the amount of detail included in the reports used to develop budgets.
Also, in their effort to streamline budgeting, leading companies use information technology to automate budgeting and facilitate workflow. These companies make sure that budget developers are thoroughly trained in new technologies. This training, together with ongoing monitoring of information needs companywide, helps best practice companies deliver the right information to managers, on time and at the right cost.
Develop budgets that accommodate change.
By developing budgets that accommodate change, companies can respond to competitive threats or opportunities more quickly and with greater precision. They can use resources efficiently to take advantage of the most promising opportunities. Furthermore, knowing that budgets have some flexibility frees budget developers from the need to “pad” budgets to cover a wide variety of possible developments. This leads to leaner, more realistic budgets.
Companies typically review budgets quarterly, monthly, or even weekly. By including in these reviews reports on changes in business conditions, companies alert managers that new tactics may be called for, if they are to meet their targets for the year. While it is important that budgets not be revised to cover up for poor performance or poor planning, best practice companies choose to revise budgets rather than adhere to budgets that do not reflect current conditions. Some companies rely on “rolling” or “continuous” forecasts rather than on traditional annual budgets. The chief difference between such forecasts and traditional budgets is that the forecast is updated with actual results as the company moves through the year. Figures for three or more subsequent quarters are projected in decreasing degree of detail.
One way in which companies build flexibility into budgets is to prioritize according to strategic importance action plans that were rejected due to resource limitations. By doing this, they can act swiftly and decisively if additional resources become available.
Another way in which best practice companies develop budgets that accommodate change is to require managers to create scenarios based on a variety of assumptions about business conditions. The affordability of powerful information technology allows for the creation of many “what if” scenarios. This practice makes it possible for companies to respond more quickly and effectively if actual conditions follow the pattern of a particular scenario. Companies also build flexibility into budgets by setting aside funds at the business-unit level to take advantage of competitive opportunities. Some companies even establish separate subsidiaries to look into promising products or technologies.
* from a series of articles on www.inc.com
The Importance of Cash Management
Business analysts report that poor management is the main reason for business failure. Poor cash management is probably the most frequent stumbling block for entrepreneurs. Understanding the basic concepts of cash flow will help you plan for the unforeseen eventualities that nearly every business faces.
Cash vs. Cash Flow
Cash is ready money in the bank or in the business. It is not inventory, it is not accounts receivable (what you are owed), and it is not property. These can potentially be converted to cash, but can’t be used to pay suppliers, rent, or employees.
Profit growth does not necessarily mean more cash on hand. Profit is the amount of money you expect to make over a given period of time, while cash is what you must have on hand to keep your business running. Over time, a company’s profits are of little value if they are not accompanied by positive net cash flow. You can’t spend profit; you can only spend cash.
Cash flow refers to the movement of cash into and out of a business. Watching the cash inflows and outflows is one of the most pressing management tasks for any business. The outflow of cash includes those checks you write each month to pay salaries, suppliers, and creditors. The inflow includes the cash you receive from customers, lenders, and investors.
Positive Cash Flow
If its cash inflow exceeds the outflow, a company has a positive cash flow. A positive cash flow is a good sign of financial health, but is by no means the only one.
Negative Cash Flow
If its cash outflow exceeds the inflow, a company has a negative cash flow. Reasons for negative cash flow include too much or obsolete inventory and poor collections on accounts receivable (what your customers owe you). If the company can’t borrow additional cash at this point, it may be in serious trouble.
What Are the Components of Cash Flow?
A “Cash Flow Statement” shows the sources and uses of cash and is typically divided into three components:
Operating Cash Flow. Operating cash flow, often referred to as working capital, is the cash flow generated from internal operations. It comes from sales of the product or service of your business, and because it is generated internally, it is under your control.
Investing Cash Flow. Investing cash flow is generated internally from non-operating activities. This includes investments in plant and equipment or other fixed assets, nonrecurring gains or losses, or other sources and uses of cash outside of normal operations.
Financing Cash Flow. Financing cash flow is the cash to and from external sources, such as lenders, investors and shareholders. A new loan, the repayment of a loan, the issuance of stock, and the payment of dividend are some of the activities that would be included in this section of the cash flow statement.
How Do I Practice Good Cash Flow Management?
Good cash management is simple. It involves:
Knowing when, where, and how your cash needs will occur
Knowing the best sources for meeting additional cash needs
Being prepared to meet these needs when they occur, by keeping good relationships with bankers and other creditors
The starting point for good cash flow management is developing a cash flow projection. Smart business owners know how to develop both short-term (weekly, monthly) cash flow projections to help them manage daily cash, and long-term (annual, 3-5 year) cash flow projections to help them develop the necessary capital strategy to meet their business needs. They also prepare and use historical cash flow statements to understand how they used money in the past.
* from a series of articles produced by: U.S. Small Business Administration
The Essence of Budgeting
Your budget should outline three key areas of your business: sales, expenses and profit.
“Think of a budget as your roadmap,” says Pam Newman, President of small business consulting firm RPPC, Inc.
“When you’re planning for the upcoming year, the budget will help you set expectations and account for potential shortfalls and the impacts of unexpected opportunities. Once you’ve created your budget, it shouldn’t be written in stone, but updated on a regular basis so that you can make the most of it.”
A basic budget is just that; a simple document that outlines three key areas of your business: sales, expenses and profit.
On the sales side, it’s all the revenues you generate through the sales of your product or services.
Expenses are twofold, encompassing direct costs and indirect costs, or overhead. “Direct costs are those that include the materials and labor needed to create your product,” Newman says. “If you’re a shoe-maker, for example, it’s the leather, laces and people that put the shoes together. The indirect costs are your rent, marketing, insurance, utilities or any other expenses not directly related to manufacturing or creation of your products and services.”
Profit is broken down into two buckets as well. Gross profits are your sales minus your direct costs, which gives you what you need to cover overhead. What’s left after you take the indirect costs out is your net profit or loss.
Regarding the last point, Newman adds that, “It’s critical that you consistently measure the difference between your gross and net profits. If, for example, your gross is positive and your net is negative, it may mean that you’re not managing overhead well or that you’re not marking up your products and services appropriately.
It’s not unusual for business owners to set prices using direct costs, but you can lose sight of those indirect costs. A couple of hundred dollars a month here or there really adds up and depletes profits, which is why consistent budget review makes such a difference. It helps you spot those patterns and make changes to correct your course.”
As far as review is concerned, Newman recommends that the budget be assessed at least once a month, calling it a “living document.” In addition, columns should be created for your projected numbers vs. actuals each month.
If you’re not on target, you need to know why.
The budget allows you to develop a history for your business, and can also help you understand where you need to make changes going forward. If your sales are double what you expected in a given month, it may indicate that your business is growing faster than you may have thought.
That may be a signal that you need to think about putting more resources into product development, adding more space, hiring or other areas, which then affects those related budget areas.
The budget is also an excellent expense-management tool. “In general, you know where your expenses are, but often, you have the opportunity to do something that makes a difference for your business, like a spot inventory purchase or in marketing through a special advertising buy,” says Newman.
“The budget can show you where you can make moves to support that unexpected expense—where you might put off an expected purchase to account for this opportunity.”
Newman acknowledges that creating and monitoring a budget can be daunting for anyone without a finance or accounting background. “You may want to sit down with an accountant, financial manager or bookkeeper to set up your initial budget,” she notes.
“After you’ve helped create and worked with your budget, you’ll find you have a document that can help you succeed throughout the life of your business.”
* from an article onwww.wellsfargobusinessinsights.com
Study Resources of the Month
As this issue is focused on Budgeting ~ here are some recommendations related to that topic:
Bonham, Langdon – Finance: Fast Track to Success (Financial Times/Prentice Hall, 2009) ISBN: 027372178X
Mason – Finance for Non Financial Managers (Hodder Education, 2007) ISBN: 0340945729
Student Recommended Resources
www.hbswk.hbs.edu/item/4860.html about professional image –April letter our thanks to Isaac
http://www.chgroup.org/pre-form.htm hospital policy on “image” could be useful our thanks to Elena
Quotes from the Gurus
It’s obviously a budget – it’s got lots of numbers in it – George W Bush
The key to successfully managing the financial side of a business is very simple – spend less than the business earns – Amit Singh
Revenue can be hard to earn and easy to lose – manage it with care – Brian Tracey
We didn’t really overspend on the budget – they just didn’t give us as much as we needed – anonymous (failed) manager