Business Page January 6th, 2002


Have You Done Your Budget Yet?

Introduction

The Trinidad and Tobago elections results or rather deadlock arising out of the December 10th, 2001 general elections in that country have had one of its possible adverse consequences averted because the Panday Administration had prepared and taken to Parliament its 2002 Budget. Had this not been the case, there would have been no authority for the spending of money in the year 2002 and the economy and the country would have grounded to a halt.

Whilst this is an exceptional case, it does underline the importance of preparing budgets well in advance of the period to which they relate. Budgets also serve a number of other purposes including aiding the planning of annual operations; coordinating the activities of all sections of the operations to blend them into one harmonious whole; communicating plans to those responsible for their achievement; motivating managers and staff towards specific goals; controlling activities, and evaluating the performance of the various budget units and their managers.

Long-Range Planning

This is not to suggest, however, that a budget is any guarantee of success or that it operates in a vacuum. A good budget is merely the quantification of the annual programme within the long-range plan of the entity. The programmes represent activities such as entry into new markets, developing new or modified products, embarking on a major advertising campaign or new means of distribution of existing products. This perhaps explains why the budget is often referred to as the annual operating plan.

Business Page was heartened by the results of the recent Business Outlook Survey which showed that 33% of the companies that responded to the Survey prepare three-year plans while 14% each prepare plans for two years and five or more years. The annual budget should therefore fit neatly into these longer term plans which are themselves prepared and rolled over, so for example entities like the Guyana Power & Light would not only have annual budgets but also five-year plans prepared and updated annually.

By the time the budget is prepared, many of the conditions defining its annual operations will have long been established. To continue with the Guyana Power & Light example, the decision to build a new power plant is made years in advance of its actual commissioning. The annual budget in the intervening period will reflect the cash flows on the construction while the post-commissioning annual budget will reflect the operating revenues and costs of running the plant. As one writer puts it, "the budget is not something that originates from nothing each year - it is developed within the context of the ongoing business and is ruled by previous decisions that have been taken within the long-term planning process."

While generally a budget is often placed in a business context, there is no reason why households, individuals and more importantly non-profit organisations should not themselves have both long-term plans as well as annual budgets.

The degree of details and the type of budget will obviously vary based on the nature of the organisation, so that in a non-profit organisation an activities-based programme budget would be considered far more relevant while in a manufacturing entity some form of flexible budgeting would be advisable given that various levels of production would have different costs. The availability of computers has certainly made the budgeting process easier since it allows for the manipulation of data to reflect various options and scenarios. They are not however a substitute for good judgement including a reading of the likely environment in which the business will be operating in the near and medium terms.

It is important not to confuse projections with reality or a budget with an authority to spend. For example, the capital budget may include the purchase of X number of computers and Y number of vehicles, but the process for approving the release of funds is not one dictated by the budget, but by specific circumstances during the period and the specific procedures for authorising expenditure.

Even the short-term budget must reflect changing conditions so that if a company recognises that it is unable to meet its budget targets, it needs to revise those targets and prepare latest estimates to reflect what would now be the amended budget.

Budgeting and Planning

Formal operating budgets are a valuable tool in the day-to-day control and measurement of company activity and when used with realistic sales and cash flow forecasting, provide a profit plan to show in advance the anticipated operating level for the coming year. Many companies have implemented procedures for preparing budgets; but these are often not prepared and updated on a systematic or consistent basis. Management must constantly revisit the need for timely completion and review of budgets to aid in evaluating and providing meaningful feedback on operations.

This provides management not only with a preview of-things to come but also an opportunity to make the changes required in order to maximize profitability. A short-range plan might cover the following areas: Sales plan; expense budgets; capital expenditure budgets; cash flow and breakeven analysis.

On the other hand, a long-range budget or operations plan should give consideration to profit objectives; marketing and sales objectives; technological changes; financial resource objectives; product planning; growth objectives.

Cash Forecasting

This is one of the most important functions of the budgeting process. Improved cash forecasting techniques provide more accurate determinations of operating cash requirements and assist in anticipating short-term financing needs. They also help in planning for certain discretionary expenditures such as equipment purchases, bonus payments, and profit-sharing contributions.

Good cash forecasting also aids in identifying funds available for investment. To invest excess funds, the company must regularly translate the book balances into the amount of available funds. Investing excess funds also requires considering the bank's cost of servicing the company's account. As mentioned above, a minimum bank balance is generally required to avoid bank services charges.

Variable Budgeting

Many companies have a static budget prepared at a given level of activity and does not make any allowance for changes in operating levels. A variable budget allows the company to forecast operating results at multiple sales volume levels. The newspaper industry is an example where variable budgeting is not only desirable but quite necessary. Paper costs, printing costs and vendors' commissions are all influenced by the level of production and sales. The directors, after discussions with its marketing people may project sales of various quantities over the coming months. Such quantities could significantly affect overall profitability due to the cost composition and the development of a variable based budgeting approach would allow management to respond in a timely and orderly fashion to any significant changes in circulation.

Conclusion

As we have said before in another Business Page article in 1992, a budget does not guarantee success but as some sage has said if you don't know where you want to go any road will take you there. On the other hand, if you have an idea of what you would like to achieve, then the best way to attain that objective is to develop a clear, detailed plan with sufficient landmarks along the way.

A budget is only a part of one of the key functions of management but the discipline involve both in the preparation and the monitoring of the budget could enhance the efficiency of the operation and will often play a deciding role in persuading bankers to advance additional funds particularly where they are needed for expansion.

It should be a minimum requirement in any organisation.