WHY IT'S IMPORTANT TO ENGAGE AN ACCOUNTANT TO HELP PREPARE YOUR BUDGETS
A Business Budget is an itemised summary of estimated income and expenses for a given period, normally one year, whereas a Cash Budget estimates actual cash receipts and cash expenditures. The Business Budget determines, in advance, the estimated profitability of the business; allows the determination of the business’ break-even-point, assists with tax planning measures, and most important, allows comparison of budget estimates against actual performance so measures can be introduced to correct negative variances.
Budgeting 101 – What you need to know
Preparation of a personal or family budget should include all essential and luxury items associated with achieving your desired lifestyle:
Essential costs include things like mortgage repayments, rent, interest on loan repayments, basic food and clothing, educational costs, rates, utilities, taxes and other similar costs that are compulsory nature.
Luxury costs include things like holidays, entertainment, private education, gambling, brand label clothing, alcohol and other similar costs of a luxury nature.
A family budget will determine the level of net income needed to achieve the desired choice of lifestyle for your whole family.
Budgets are only an estimate of your future cash requirements. Individuals and families should continually analyse all aspects of cash receipts and payments to allow for any unforeseen events. Even the tightest budgets can improve with a little manoeuvring and adjustment of individual costs.
Preparation of a business budget requires a detailed review of past and future financial transactions, as well as economic indicators, seasonal and interest rate fluctuations and other external factors. Budgets must be based on meaningful criteria and most importantly, controlled with thoughtful decision-making based on logic and not a gut feeling. Good planning and budgets are also the cornerstone to achieving business ideas. It provides a yardstick or measure to compare and control your actual performance. “You need to know the score to win” and “If you can’t measure it, you can’t manage it,” are common truisms relating to planning and budgeting.
Projected Profit & Loss Statements are the estimated Sales and Expenditures over a set period. It is critical the structure of the projected P&L Statement is the same as the business Chart of Accounts. This will allow Management to compare actual results with the projected P&L and to rectify major variances.
The most difficult aspect of the projected P&L is the projection of the sales volume of the business. This requires an understanding of climatic conditions, competition, economic conditions, geographic location, demographic details and psychographic habits of potential customers and the relevant industry, and can only be achieved with extensive market research to determine the potential levels of demand for the business products or services.
The estimation of contractors’ receipts and professional fees is less complicated than the estimation of sales volume, as it is largely determined by chargeable hours. In estimating fees, management must take into consideration non-working days, working hours, idle time, public holidays, annual leave, sick leave, long service leave, seasonal factors and economic indicators.
BUSINESS CASH BUDGET
The business cash budget uses the sales information from the projected P&L Statement to show estimated cash receipts and payments. It is important to realize a cash budget involves actual cash movement and should not be confused with the projected P&L Statement. A cash budget should warn of future cash shortages so actions can be taken to avoid a liquidity crisis. This might include reduction or postponement of expenditure, tightening up credit control of debtors, adjusting price levels and/or re-arranging finance.
FIXED & VARIABLE COSTS
All projected expenses should be categorised into Fixed and Variable Expenses.
Fixed Expenses - essential to operate a business and normally established by contracts, leases, agreements, governments, semi-governments costs and service providers’ charges. Normally incurred irrespective of the level of sales, for example: rent, salaries, insurance etc.
Variable Expenses - vary in accordance with the level of sales. Owners and managers must continually analyse sales performance and control both fixed and variable expenses to achieve the budgeted net income. Variable costs are normally expressed as a percentage of sales; this includes the cost of goods sold, casual wages, advertising and marketing, motor vehicle expenses, and any other major variable costs directly associated with the sales volume of the business.
The contribution margin is the amount available to meet the fixed costs of the business. It is obtained by subtracting all variable costs from sales. A relatively low contribution margin with high fixed costs indicates the potential of financial disaster if the projected sales is not achieved. If this occurs management must take immediate corrective action to reduce the fixed costs of the business or analyse its marketing strategy to increase sales. Conversely, a high contribution with low fixed costs will indicate high profits in good trading periods.