Business Budgeting: Does My Business Need a Budget?

By Alex Vorobieff

Do you feel that budgets never seem to exactly predict the future and it seems there is always something different missing from the forecast each month?

The purpose of business budgeting is not to predict the exact month by month results of the company. There are too many scenarios that could happen in a given year to precisely predict each month’s results.

Static Budget vs. Dynamic Budget Model

Business Budgeting: Does My Business Need a Budget?The most basic budget is a static budget with unsupported estimates of revenue and expenses. A dynamic budget model has revenue and expense numbers supported by revenue and cost drivers that are tied directly to how the company does business.

A dynamic business model is a tool that helps a business leader make informed business decisions as conditions and variables change. The process of preparing a working budget model for your company is one of the best ways to learn how the actions performed by your sales people, employees, customers, vendors, etc, impact the revenue, expenses and ultimately the profitability of your company.

Why Not Compare Results to Last Year?

Often, businesses compare their results to the same period last year to judge how they are performing. In today’s business climate, conditions change quickly. Comparing results to last year, assumes things haven’t changed.

  • Does your company charge the same price for its product?
  • Have your labor costs increased?
  • Have you spent additional money on a sales campaign and need additional sales to cover those costs?
  • By comparing results to a budget, you can see how your business is performing compared to your current assumptions and not last year’s circumstances.

Mid-Year Unforeseen Events

When those unforeseen events occur, having a working budget model allows you to quickly incorporate the new information to determine if you need to make difficult decisions. If your company loses a customer that represents 25 percent of annual revenues, a working budget model would allow you to see the financial impact on your company and help quantify how much costs would need to be cut.

On the flip side, if you secured a new contract that would increase your sales by 50 percent a working budget model would help you determine how much you could afford to take on in additional expenses while still growing profits.

Variances Between Budgeted and Actual Results

When the budgeted amounts differ from actual results, looking for the reason why there is difference helps you understand your business better. What was off? Was an assumption wrong? Does the budget predict $5.00 in sales revenue per unit sold and your actual price after discounts is $4.86? Are your labor hours too low in the budget or is the night shift using too many overtime hours? By comparing the assumptions in the budget to actual results, you can see if the budget model needs refining or if parts of your business are not performing as they should.

The process of preparing a budget and comparing it to actual results helps managers better understand how their business works which helps them make informed business decisions as conditions change.

Alex Vorobieff provides fractional CFO services to companies that want to use their financial information to make informed business decisions. Check out his company’s website and his related blog.
Originally published: Aug 24, 2011

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