Budgets during the operational phase
Once you have got through the initial start-up phase, it can be a good idea to set further targets for your business and plan what you will need to do in order to achieve these targets. Budgets are a useful tool in this context.
It is much easier to draw up a good budget when you have been running your business for a while. You will then be able to base your budget on actual figures from your accounts, and you will know 'where the shoe pinches'. To plan next year's revenues and expenses, it can be a good idea to think through what you will need to do in order to achieve the targets you have set for your business.
- What are general price trends like?
- What are the price trends regarding your particular products or services like?
- Are any changes taking place within the industry which will affect revenues or expenses?
- Will I have to invest in new machinery or other equipment?
- How should I finance any new investments?
- Should I expand the business?
- Should I take on more employees?
- Are any operational changes planned which will affect expenses and revenues?
You and your employees know the business better than anyone else. It is a good idea to involve your employees in the budgeting process.
Many people have a tendency to be a little too optimistic in their budgeting. Revenues tend to be overestimated and expenses tend to be underestimated. In a budget context, you should be objective with regard to revenues and make sure you include all your likely expenses.
Budgeting is primarily about three budgets:
- Investment budget
- Profit and loss budget
- Liquidity budget
This budget must present an overview of your planned investments over the next few years.
Investment budgets do not need to be any more complicated than an overview of essential investments, investment costs and how your investments will be financed. It can also be a good idea to state in the budget the number of years over which the fixed assets will be written-off.
Profit and loss budget
In a profit and loss budget, you can predict your anticipated revenues and expenses during the budget period, and the extent to which your business is expected to generate a profit or incur a deficit. You can compare this budget with the actual accounts during the year, enabling you to identify any undesirable trends at an early stage.
Most companies prepare next year's budget during the autumn. You should actively use the accounts for the current year in the budgeting process and prepare a forecast (a discretionary assessment) for your financial results through to the end of the year. You will then have good historical figures to use as a basis for next year's budget. You should also review all the various accounts items and consider possible changes to expenses or revenues which could have consequences for the budget.
For example, if you know that next year you will produce and sell a new product, you will inevitably incur new costs relating to everything from production to marketing and sales. A carefully considered calculation will form a good starting point for assessing expenses and revenues for this product.
If you intend to carry out a major investment, you must also consider whether the investment should be expensed immediately or written off over time. This will affect the profit and loss budget.
In order to use your budgets as a management tool during the year, you should split them up into periods. Distribute revenues and expenses between the relevant months. You should also consider whether there are any seasonal variations, and calculate revenues and expenses on a month-by-month basis. When you compare the budget each month against the actual accounts, you will be able to identify any deviations and adjust your course at an early stage.
Liquidity means solvency or ability to pay. A liquidity budget shows the cash flow within the company. In the budget, you are in reality attempting to predict expected movements in your bank account. This will enable you to see whether you have sufficient funds to settle your obligations as they fall due for payment. If you realise that you are likely to have problems fulfilling your financial obligations during a particular period, you could for example agree an overdraft with your bank in advance.
If you have prepared an investment budget and a profit and loss budget, you will have a good starting point when you start work on your liquidity budget.
It can be a good idea to start with your revenues. If you sell on credit and have a 30-day payment deadline, the revenues in your liquidity budget will be received a month after the revenues are included in the profit and loss budget. Remember to include any VAT in the liquidity budget. It is the cash flow which you should budget here.
You should then review your expenses. In this case, you must look at the payment deadlines on the invoices. If you have a month's credit, you will not have to pay for your purchases until one month after the expense was included in the profit and loss account. In the liquidity budget, you should also include value added tax on the invoice.
If you have planned major investments, you must also include these. When will they have to be paid for? Will I have to take out a loan in order to cover the cost? Both contributions and any loan repayments must be included in the liquidity budget.
VAT must normally be paid six times a year. For example, VAT for January and February must be paid in April. You must look at your revenues and expenses in January and February in order to calculate how much VAT you will have to pay in April.