Budgets and how to put them together
A budget is nothing more than a written estimate of how an organization — or a particular
project, department, or business unit — will perform financially. If you can accurately
predict your company's performance, you can be certain that resources such as money,
people, equipment, manufacturing plants, and the like are deployed appropriately.
Kinds of budgets
When it comes right down to it, you can budget any activity in your organization that has a
financial impact. Two of the most common budgets are
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Cash budget: An estimate of a company's cash position for a particular period of
time.
Operating budget: A business's forecasted revenues along with forecasted
expenses, usually for a period of one year or less.
Line items in your operating budget may include:
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Labor budget: The total labor cost to be expended for a set period of time calculated
by taking every person in an organization, department, or project and multiplying
the number of hours they are expected to work by their wage rates.
Sales budget: An estimate of the quantity of goods and services that will be sold
during a specific period of time.
Production budget: A forecast thatstarts with the sales budget's estimates of the
total number of units projected to be sold, then translates this information into
estimates of the cost of labor, material, and other expenses required to produce
them.
Expense budget: An estimate prepared for travel, utilities, office supplies,
telephone, and many other common business expenses for a given period.
Capital budget: The total costs and maintenance fees planned for your company's
fixed assets.
The best kind of budget is the one that works. You can choose from three key approaches to
developing a budget:
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Top down: Budgets are prepared by top management and imposed on the lower
layers of the organization. Top down budgets clearly express the performance goals
and expectations of top management, but can be unrealistic because they do not
incorporate the input of the very people who implement them.
Bottom up: Supervisors and middle managers prepare the budgets and then
forward them up the chain of command for review and approval. These budgets
tend to be more accurate and can have a positive impact on employee morale
because employees assume an active role in providing financial input to the
budgeting process.
Zero-based budgeting: Each manager prepares estimates of his or her proposed
expenses for a specific period of time as though they were being performed for the
first time. In other words, each activity starts from a budget base of zero. By starting
from scratch at each budget cycle, managers are required to take a close look at all
their expenses and justify them to top management, thereby minimizing waste.
Each has its advantages and disadvantages, and each approach can work well, although the
pendulum is clearly swinging in favor of the bottom up approach.
When your expenditures exceed your budget, you can do several things to get back on track:
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Review your budget. Before you do anything else, take a close look at your budget
and make sure that the assumptions on which it is based are accurate and make
sense in your changing market. If your market is growing quickly, you may need to
adjust up your estimates. Sometimes, it's the budget — not the spending — that is
out of line.
Freeze spending. One of the quickest and most effective ways to bring spending
back in line with a budget is to freeze expenses such as pay raises, new staff, and
bonuses.
Postpone new projects. New projects, including new product development,
acquisition of new facilities, and research and development, can eat up a lot of
money. However, if you are too zealous in curbing spending when you need to
develop new products or services to compete, the result can be disastrous for the
future growth and prosperity of the company.
Lay off employees and close facilities. This is the last resort when you're trying to
cut expenses. Although these actions will result in an immediate and lasting
decrease in expenses, you also face an immediate and lasting decrease in the talent
available to your organization. Productivity and morale of remaining employees may
also suffer.
To create your monthly budget
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Categorize your expenses.
When you begin setting up a monthly budget, start with big categories before
breaking your budget down into smaller expense categories.
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From your list of expenses, develop two separate budget lists, one for essentials and
the other for extras.
Within each general budget category, some items are essential (the mortgage or
rent payment, electric bill, and groceries); others are extra (new furniture, gifts, and
pizza delivery).
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Look through these lists to find flexible budget expenses where you can cut back.
Put a star next to these flexible items so you can identify them.
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Estimate what you spend.
Go through your checkbook and any other receipts or records you’ve kept over the
past few months so you can track how much you actually spend on both essentials
and extras.
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Add up your budget essentials list and the extras list separately.
By keeping the lists separate, you can make cuts more easily, if you need to.
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Subtract the essentials total from your monthly income and, if you have money left
over, subtract the extras total from that amount.
If you still have money left over, great! Look into a savings or investing plan (talk to
your bank or a certified financial planner for help setting up a plan).
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If your extras list takes you into negative numbers, start looking for places to cut
back.
You can also trim from the extras list to put more money toward debt repayment if
that’s a high priority in your financial picture.