We have explored why it is important and essential for businesses to prepare a budget. Now, let's look at how time comes into the equation.
What is a budgeting timeframe?
The budgeting process for most large companies usually begins four to six months before the start of the financial year, while some may take an entire financial year to complete.
Most organisations set budgets and undertake variance analysis on a monthly basis. Starting from the initial planning stage, the company goes through a series of stages to finally implement the budget. Common processes include communication within executive management, establishing objectives and targets, developing a detailed budget, compilation and revision of budget model, budget committee review, and approval.
Translating Strategy into Targets and Budgets
There are four dimensions to consider when translating high-level strategy, such as mission, vision, and goals, into budgets.
- Objectives are basically your goals, e.g., increasing the amount each customer spends at your retail store.
- Then, you develop one or more strategies to achieve your goals. For example, the company can increase customer spending by expanding product offerings, sourcing new suppliers, promotions, etc.
- You need to track and evaluate the effectiveness of the strategies using relevant measures. For example, you can measure the average weekly spending per customer and average price changes as inputs.
- Finally, you should set targets that you would like to reach by the end of a certain period. The targets should be quantifiable and time-based, such as an increase in the volume of sales or an increase in the number of products sold by a certain time.
| Objectives | Strategies | Measures | Targets |
|---|---|---|---|
| What are you trying to achieve? | How are you going to achieve it? | What are the input and output measures? | Quantifiable and time-based |
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The terms ‘budget’ and ‘forecast’ are often substituted for each other, giving rise to the assumption that the two terms have the same meaning, although they actually have different, if related, functions.
It may help to think of a budget as a fixed representation of the goals and objectives of the business. An organisation prepares a budget as a plan of how they intend to operate over a certain period, and they use it to guide their decision-making over that time. A forecast, by contrast, uses historical data to build a picture of what may happen in the future if the planned budget is followed, which can be based on a varying number of scenarios. The forecast is, therefore, a useful tool to assess whether the business is moving in the right direction at any point during the budget period by providing a point of reference for where the business is expected to be.
Obviously, a budget is prepared using predictions and expectations of what the future holds: an effective plan takes into account factors that might affect the business’s ability to meet its goals and objectives. However, budgets and forecasts operate independently of each other in terms of systems and purpose.
Milestones and performance indicators are both measures of performance and significant objectives on a budget.
Performance indicators are a means of measuring performance. Measures can be quantitative or qualitative. The frequency of reporting milestones and performance indicators will depend on the budgetary objective.
Some examples of milestones or performance indicators in the budgeting context might be compliance with scheduled payment dates, meeting debt reduction targets or meeting certain unit costs.
Performance indicators should, where possible, meet the SMART criteria; that is, they should be Specific, Measurable, Actionable, Realistic and Timely.
The following 2-minute video explains what SMART goals are and how they help you to achieve goals.
Milestones
A budget is not a real plan without milestones. Milestones are used to manage responsibilities, track results, and review and revise. And without tracking and review, there is no management and no accountability.
Just as tactics are needed to execute strategy, so too are milestones required to achieve tactics. Typically, there is a close match between tactics and milestones.
Milestones turn tactics into practical, concrete terms with real budgets, deadlines, and management responsibilities. They are the building blocks of strategy and tactics. Milestones are essential to ongoing plan-vs-actual management and analysis, which is what turns planning into management.
Meaningful performance measures track business results because the achievement of business results is what defines performance. Completing a task or activity, such as reaching a milestone, doesn’t represent performance. There are many examples of organisations where projects, initiatives or actions have worsened performance! That’s why milestones aren’t meaningful measures.
A milestone is a point in time when a particular action has reached a crucial stage that indicates it’s progressing as planned. Action timelines and their milestones are best guesses (hopefully informed theories) about what’s going to improve business performance. But milestones also need measures to test if they’re working or not.
A milestone is reached, or it isn’t. It’s that simple. If milestones are used as measures, it can drive the wrong behaviour, with people focusing on manipulating the timeline rather than ensuring that their actions lead to the intended improvements in business performance.
Six Budget Milestones
An effective budget process communicates organisational goals, allocates resources, provides feedback, and motivates employees. To standardise the budgetary process, organisations should use budget manuals, budget forms, and formal procedures. Tools such as software, the Program Evaluation and Review Technique (PERT), and Gantt charts facilitate the budgeting process and its preparation. Adhering to the budget timetable is essential; if the process is rushed, unrealistic targets may be set.
The budget process should align with the company's needs, organizational structure, and available human resources. It involves establishing goals and policies, setting limits, identifying resource needs, examining specific requirements, providing flexibility, incorporating assumptions, and considering constraints. A thorough analysis of the company's current status is necessary, and the time required for budgeting increases with operational complexity. A budget is formulated based on past experiences and adjusted according to the current environment.
The six (6) steps in the budgeting process (milestones) are:
- Set objectives
- Analyse available resources
- Negotiate to estimate budget components
- Coordinate and review budget components
- Obtain final approval
- Distribute the approved budget
A budget committee should review budget estimates from each segment, make recommendations, revise budgeted figures as needed, and approve or disapprove of the budget.
Key Performance Indicators
Running any business effectively requires good decision-making, which is based on good management information. All businesses need to monitor profitability and cash flow carefully and use management accounts for this purpose.
However, to boost profitability and cash flow, a business also needs to understand and monitor the key 'drivers' of a business. A driver is something that has a major impact on the performance of the business.
Key performance indicators (or KPIs) are metrics used to help a business define and measure progress towards achieving its objectives. They are quantifiable measures that can be expressed in either financial or non-financial terms and reflect the nature of the business. Examples of key performance indicators include:
- Unit sales
- Return on investment
- Market share percentage
- Product quality.
There is a multitude of internal and external factors affecting the performance of every business. The sheer volume of information available to management can be a distraction, so managers need to focus on a handful of key indicators, which:
- Reflect the performance and progress of a business
- Are measurable
- Can be compared to a standard, such as a budget or last year’s figures
- Can be acted upon
Monitoring sales, for example, will not necessarily help improve sales performance. By contrast, understanding the drivers behind sales can provide a breakthrough.
There are two (2) main types of performance indicators:
- Financial indicators are found in the accounting records and are expressed in dollar terms.
- Non-financial indicators are commonly expressed in real terms and often make use of qualitative data.
Financial Performance Indicators
Financial performance indicators generally focus on profit. They are sometimes called ‘financial performance ratios’ since they can be expressed as a relationship between net profit (or gross profit) and sales or between net profit (or gross profit) and cost of sales. The net profit is also referred to as the return.
Examples of relationships of profits are:
- percentage of net profit to sales
- percentage of gross profit to sales
- percentage of net profit to cost of goods sold
- percentage of gross profit to cost of goods sold.
Other financial performance indicators include:
- Market share: the percentage of the company’s sales to the total sales of all competitors (including the company) in a state or country or an area within these
- Return on capital investment: the percentage of net profit to the capital invested in the organisation or profit centre
- Sales to investment: the sales generated by a dollar of investment
- Collection period or accounts receivable turnover: the average number of days taken to collect accounts receivable
- Inventory turnover: the number of times the inventory is replenished on average per annum.
Non-financial Performance Indicators
Non-financial performance indicators are not measured directly, and the indicator chosen will depend on the area that the business needs to focus on.
The following are some examples of the types of non-financial performance indicators that can be implemented:
- Customer complaints: the number of complaints received from customers as a percentage of the total number of customers served
- Defective units: the number of defective units as a percentage of the total number of units produced
- Employee turnover: the number of employees who have left the business as a percentage of the total employees
Responsibility Accounting
In order to achieve the goals of an organisation, efficient systems and processes must be in place. This will include:
- Monitoring and reporting back to management.
- Implementing control procedures.
- Making evaluations and taking appropriate remedial action to rectify deviations.
Individual members of the various business units are responsible for different tasks and functions. Where individuals work together to achieve organisational goals, it is referred to as ‘goal congruence’. An accounting system that attempts to encourage goal congruence is called ‘responsibility accounting’.
Costs and revenue may be linked to an organisational chart that represents the responsibilities of the different sections or centres of the organisation, e.g. marketing, production, administration, quality management, sales, accounts, purchases, payroll, training and human resources.
In responsibility accounting, each division, branch or department is referred to as a ‘responsibility centre’. A responsibility centre is an organisational subunit, and the manager of each subunit is accountable for the activities and performance of that subunit.
The concept of responsibility accounting is that the person in charge has control over the operations and spending of a particular section and is accountable to others in the organisation for its performance.
The persons in charge of particular sections are only held accountable for the revenue or costs that are under their control, namely:
- Production or administration centre – The manager is accountable for costs only.
- Marketing or sales centre – The manager is accountable for the revenue earned.
- Head office or chief financial officer – The manager is accountable for profit. This will include both revenue and costs.
- Board of directors, chief executive officer – Held accountable for profit and capital investment.
Some businesses have products that only sell well at specific times of the year – for example, if you manufacture sunscreen, you’ll find that sales peak in summertime, and if you’re in the business of snow gear or run a ski resort, the logical trend would be a jump in sales when the weather cools. Similarly, the busiest time for accountants is tax season, and for florists, it’s Valentine’s Day or Mother’s Day.
What is a seasonal period?
Seasonal movements represent fluctuations that repeat each year. Seasonal effects on data will create variations that can impact the outcomes of a business.
Using historical data of previous records will provide insight as to whether a business is affected by factors such as seasonal changes or holidays and events occurring annually.
Seasonal periods can be:
- Monthly
- Quarterly
- Annual
This can include breaking down the annual budget into seasonal periods for:
- Rent payments
- Lease payments
- Utilities
- Tax
- Insurance
- Inventory and supplies
- Payroll
- Loans
Factors that would need to be considered for seasons would be:
- Hiring staff
- Stock inventory
- Purchases
- Upgrades to IT
- Seasonal decorations
- Seasonal trades such as Easter, Valentine's and Christmas
This can affect changes in:
- Employee wages (for example, overtime during Christmas)
- Costs associated with hosting seasonal events
- Extra costs in postage and shipping
- Staff on leave
- Increases in petrol, transport or postage
Plan for the highs and lows
The first thing to do is to build a sales plan, broken down into months or even weeks, and by category, to get a good grip on exactly how much you sell, what you sell and when you sell it. This will allow you to identify the months of peak sales and those with the lowest sales and to adjust stock accordingly to avoid overbuying. It’s a good idea to develop a sales and cash flow forecast as well.
Paying attention to market and consumer needs
Keeping an eye on market and consumer trends is important for a seasonal business as it allows you to market smarter according to consumer needs and wants in both low and high seasons. For instance, you’re a sunscreen retailer that typically sees a sales boom in summer, but you read that consumers are increasingly becoming more conscious of skin cancer risks, even in winter. A good marketing approach would be to capitalise on this trend – perhaps by sending out a customer email during low season reminding them of the benefits of SPF.
Trends can also be found within your own database – for instance, noticing that a specific product is especially popular with certain demographics, such as young people or women, can help you better target these groups.
These strategies will help assist you in identifying how to best create the budget effectively against the seasonal periods and align with organisational operating procedures.
Try to answer the following quiz questions to test your knowledge regarding this topic:
Consider the following questions:
You are the bookkeeper for a flower-growing business:
- What would be the effects of the seasons on creating the yearly budget?
- Revenue fluctuations: Seasonal changes can significantly affect the demand for flowers. For example, spring and summer might see higher sales due to weddings and events, whereas winter might see lower sales except for the holiday season.
- Production costs: The cost of growing flowers can vary with the seasons. Heating costs in winter, cooling in summer, and the varying availability and cost of water and other inputs need to be considered.
- Inventory management: The business must plan for peak seasons by growing and maintaining sufficient inventory, while also managing the risk of spoilage during off-peak times.
- Labour costs: The need for labour can fluctuate with the growing and harvesting cycles, requiring more workers during planting and harvesting seasons and fewer during other times.
- Marketing expenses: Advertising and promotions might be higher before and during peak seasons to maximize sales.
- What would be the milestones for this business?
- Planting season start and completion: Ensuring that all flower beds are planted by a specific date.
- First bloom: Marking the period when flowers start blooming is crucial for planning harvest and sales.
- Peak harvest periods: Identifying the times when the majority of flowers are ready for sale.
- Key sales dates: Preparing for high-demand periods such as Valentine's Day, Mother's Day, and wedding seasons.
- End-of-season clearance: Selling off remaining stock before the next planting season begins.
- What performance indicators would be used in the budget?
- Revenue growth: Comparing sales figures year over year and season over season.
- Cost of goods sold (COGS): Monitoring production costs to ensure profitability.
- Gross margin: Evaluating the profitability of the flowers sold.
- Inventory turnover: Measuring how quickly inventory is sold and replaced.
- Labour efficiency: Tracking labour costs against the volume of flowers produced and sold.
- Customer satisfaction: Gathering feedback to ensure repeat business and positive word-of-mouth.
- Sales per marketing dollar: Evaluating the effectiveness of marketing campaigns.
- What would be the seasonal periods with regard to operating a flower-growing business?
- Summer (December-February):
- Activities: Peak growing and harvesting period, with many flowers in full bloom. Preparation for high-demand periods like Christmas and New Year.
- Demand: High demand for summer weddings, events, and the holiday season.
- Autumn (March-May):
- Activities: Continued harvesting and preparing for the end of the main growing season. Planting fall blooms.
- Demand: Steady demand, with potential peaks for autumn weddings and events.
- Winter (June-August):
- Activities: Maintenance of greenhouses, preparing soil and beds for spring planting. Focus on growing flowers that thrive in cooler temperatures.
- Demand: Generally lower, but there are opportunities for sales around winter events and holidays.
- Spring (September-November):
- Activities: Planting new flowers and preparing for the upcoming peak growing season. Early blooms start to appear.
- Demand: High demand for spring weddings, events, and the lead-up to the summer season.
