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The Budget Must Have the Support of Management

The budget must undeniably have the support of management at all levels of the organization. The support of both the top-level managers and the lower-level managers is crucial to garner the support of the employees of the enterprise.

The Budget Must be a Motivating Tool

The budget should motivate and inspire all the people in the enterprise to work toward attaining the enterprise’s goals. Furthermore, the budget must encourage everyone to work together for the improvement of the organization. The budget should not be viewed as a rigid plan, or as a device for top management to use in assessing blame.

The Budget Must Address the Enterprise’s Goals

Essentially, a budget must begin with the enterprise’s short and long-term plans and goals. The budget should not just to recreate the enterprise’s previous year’s results with slight changes. It must include valuable input from planning so that the budget becomes a powerful guiding tool.

The Budget Should be Coordinated

The budget must be coordinated to smoothly operate within the different business units of an enterprise. For example, the sales manager will strive to increase the sales of the enterprise. However, the credit manager will be extremely keen in limiting bad debt write-offs.

The Budget Should be a Correct Representation

The budget should accurately represent what is expected to happen. An inaccurate budget will not have the support of managers and employees directly affected by it and will encourage managers of an enterprise to fabricate “budgetary slack” into their budgets.

The Budget Should be Flexible

A key factor in the success of a budget is whether it is flexible or not. Most successful budgets are flexible. A flexible budget permits an enterprise in going ahead with plans that are strategically important to the enterprise. However, a rigid budget becomes an excuse for not executing strategically important plans.

Budgets are most commonly prepared for the company’s fiscal year, but often three-, five-, and ten-year budgets are planned, as well as budgets of shorter duration. A different year basis other than fiscal year is possible, but is not recommended, because fiscal year financial statements can be easily compared to the budget. Budgets are often further broken down into monthly or quarterly sub-periods, or a continuous or rolling budget is used. A continuous budget has a month, quarter, or year basis, and as each period ends the upcoming period’s budget is revised and another period is added to the end of the budget. Software is available for implementing this type of budget.

Budget Process

Methods of budget preparation differ between companies, but all fall somewhere on a continuum between entirely authoritative and entirely participative. In an authoritative budget (top-down budget), top management sets everything from strategic goals down to the individual items of the budget for each department and expects lower managers and employees to adhere to the budget and meet the goals. In a participative budget (bottom-up or self-imposed budget), managers at all levels and certain key employees cooperate to set budgets for their areas, and top management usually retains final approval.

Characteristics of a Successful Budget

• Should be flexible.
• Must be realistic.
• Should be evaluated regularly.
• Should have a financial format.
• Must be well planned and clearly communicated.

Operations Goals

Operational goals define the routine tasks that are necessary to run an organization. When a company functions efficiently, employees are more productive and can reach their full potential. Profits can be made. Setting operational goals lets you manage a business, allowing it to grow in a scalable manner.

Regardless of the phrases you use, operational goals are items an organization wants to accomplish over the course of one to two years. They are (typically) defined by these characteristics:

• Limited to a single department or division
• Associated with a budget
• Tracked to see “what you get” with the budget you have
• Measurable and actionable
• Shorter time frames

Linking Operational Goals to Strategic Goals

A strategy is a high-level plan to accomplish items of key importance for your organization over the course of three to five years. Strategic goals are the building blocks of a strategy. They can be organized in multiple ways: by perspectives (financial, customer, internal process, and people) or by division and department.

Operational goals should be ingrained in every area of your strategic plan. You won’t be able to achieve your strategy otherwise. If you have too many operational goals tied to one strategic goal and not enough (or any) tied to another, consider shifting resources and prioritizing your operational goals differently.

Also, you may have operational goals and plans aligned by department, such as a marketing operations plan, customer success plan, product development plan, etc. Check all your work plans to make sure they cover all your strategic goals.

Setting Goals Vs. Setting Targets

An important distinction to make here is that goals are different than targets. We’ve established that operational goals specify (in a measurable way) the short-term tactics an organization will take to achieve its strategy. Targets are tools that allow you to define expected progress in even smaller steps that align with the details and deadlines of operational goals. More specifically, targets are typically set by quarter throughout the one- to two-year time span of an operational goal.

Operational Goals and Projects

A strategic plan has clearly defined goals, measures, and projects. Your strategic projects contribute to your goals so you can improve your measures. When you’re doing operations planning, operational goals and projects will be intermixed—and that’s perfectly normal. Similar to how goals and targets can overlap, so can goals and projects. Sometimes you’ll measure a longer term operational goal, like improving miles and miles of paved roads; and sometimes you’ll track and measure a shorter project, like widening a bridge. From a strategy standpoint, the bridge widening will look like a project, but from an operations perspective, it’s both a goal and a project. Ultimately, a lot of your activities will directly or indirectly link to your strategic goals.

Operational budgets are usually consumed by projects, so those projects start to have goal-like “symptoms.” Because of this fluidity of terminology, it’s important to regularly evaluate operational goals and projects to ensure they are on track and aligned with the organization’s strategy. This helps you be continually aware of how the progress you’re achieving is helping the company, all the way up to the strategic level.

Your strategy won’t be effective if you don’t have those operational goals in place and on track. Operational tactics and strategic vision have a reciprocal relationship. Plus, if you’re in a cost-cutting environment, it will be easier to defend your budget or work plan if it links closely to the strategy. You’ll be able to clearly show that you’re thinking strategically and using resources in a way that supports the strategy.

• These goals are focused on the monetary aspects of the business such as reducing costs or improving revenues.
• These goals tend to focus on improving productivity or quality so as to differentiate the company from its competitors.
• Cultural/Workforce. These goals are designed to improve the workforce’s capabilities, commitment, and discretionary effort.

Strategic Goals

Strategic goals let executives and upper management determine where they want to go. Basically, you want to get from your current state to a future enhanced position. Strategic goals are the outcome that you desire.

Perhaps you want to produce more products. You might want to reduce overhead. Maybe you want to enter new markets. Setting strategic goals allows you to evaluate where you are and challenge yourself to end up at a better place.

Some examples of strategic goals include:

• Increase customer conversion rates
• Launch a new product
• Increase revenues
• Improve training programs
• Diversify your revenue streams

Tactical Goals

Once you set strategic goals, you can build up your tactical goals. These further define your strategic objectives. You can plan tactical goals in advance by breaking down your strategic goals.

For example, let’s say that your strategic goal is to boost sales by 15 percent by the end of the quarter. Tactical goals would be the campaigns that you set up in each department to increase sales. One strategic goal should have multiple short-term tactical goals that create the momentum to achieve the overarching objectives.

Tactical goals can build on one another. You may have to accomplish certain tactical goals before you can take on more to produce a consequence. On the other hand, tactical goals can also be independent of one another. You can have several separate tactical goals that you can work on at once to bring about a result. Think of them as the action steps that provide a direct line to your strategic goals.

Performance goals

Performance goals are short-term objectives that an employee is expected to achieve within a set period of time. These goals are usually attached to specific job positions and are determined after considering the tasks and duties an employee is required to perform in that position. Performance goals are often a subset of and add up to overall company goals. They let employees know what is expected from their position, so it is important to define performance goals as clearly as possible and make them easily measurable.

Performance goals are what employees work to achieve. They are based on the goals and priorities of an organization and are tied to specific job positions. They focus on the job duties and productivity of an employee, and are designed to integrate an employee’s achievement with the overall goals of the company.

Development goals

Development goals, on the other hand, are set for the professional development of an employee. They focus on the areas the employee wants to develop for growth and advancement in their career. They encourage enhancement in performance through learning and development. Development goals are chosen and set by the employee, but they often involve active support from management. The employee usually looks up to the organization to help fulfill their professional development goals, such as through skill-based training and financial sponsorship.

How to set performance goals

Setting performance goals for employees is an important responsibility of a manager. Use the following steps to set measurable goals to improve the performance of your team and drive growth in your organization:

Invite employees to participate

Encourage employees to identify and suggest their own job-specific goals. Employees will be more motivated to achieve the goals that they set rather than those imposed by the management. Discuss with each employee their individual goals for a given performance period. Ensure that the goals align with the company objectives. Once you finalize the goals, develop an action plan for their achievement.

Review company objectives

Consider your company’s goals to connect performance goals for each employee with the mission and strategy of the company. Performance goals become effective when employees know how they contribute to the company’s growth. Start with an overall company goal and divide it into smaller goals for each employee. For example, if the management wants to grow sales by 4%, find out how each individual can contribute toward that achievement.

Use the SMART method

You can use the SMART method of setting goals to ensure that employee performance goals are specific, measurable, achievable, relevant and time-bound. Each goal should clearly tell the employees what they are expected to achieve and within what time frame. Quantify the achievement to make it measurable, and try to keep the target challenging but within the attainable range.

Specific

You should clearly define goals in specific terms as to what is to be achieved. For example, saying “start publishing a monthly newsletter” is better than making a generic statement like “improve communication with team members.”

Measurable

Goals should be measurable, making it easy to track their achievement. For example, “reduce process time by 10%.” In addition to a numeric quantity, you can also measure goals through a change in behavior, quality, cycle or processing time and efficiency.

Achievable

Goals should be achievable with a reasonable amount of effort. You should set realistic goals that can be achieved within the pre-determined timeframe with sincere efforts and available resources.

Relevant

All goals should be pertinent to the main objective, such as achieving company goals.

Time-bound

You should clearly specify a timeframe to achieve goals. For example, if you want to increase productivity by 10%, you should also state whether it should be achieved in one year, two years or by a certain date.

Operating budgets include the sales budget, production budget, direct materials budget, direct labor budget, overhead budget, cost of goods sold budget, selling and administrative budget, and pro forma (or budgeted) income statement.

Financial budgets include the capital budget, pro forma balance sheet, pro forma statement of cash flow, and cash budget.

Operating Budget

The operating budget contains the expenditure and revenue generated from the daily business functions of the company. The operating budget concentrates on the operating expenditures, including cost of produce sold in the market or popularly known as cost of sold goods (COGS) and the revenue or income. COGS is the cost of direct labor and direct materials that are tied to production.

The operating budget also depicts the overhead and administration costs tied directly to manufacturing the goods and providing services. However, the operating budget will not contain capital expenditures and long-term loans.

An operating budget consists of all revenues and expenses over a period of time (typically a quarter or a year) which a corporation, government, or organization uses to plan its operations.  An operating budget is prepared in advance of a reporting period as a goal or plan that the business expects to achieve. Below is an example of a downloadable budget template and an explanation of how to prepare one.

Components of an Operating Budget

The main components of an operations budget are outlined below. Each business is unique and every industry has its nuances, but these items are general enough to apply to most industries.

Revenue

Revenue is usually broken down into its drivers and components. It’s possible to forecast revenue on a year-over-year basis, but usually, more detail is required by breaking revenue down into its underlying components.

Revenue drivers typically include:

• Volume (units, contracts, customers, products, etc.)
• Price (average price, per unit price, segment price, etc.)

Variable costs

After revenue, variable costs are determined. These costs are called “variable” because they depend on revenue, and are often calculated as a percentage of sales.

• Variable costs often include:
• Cost of goods sold
• Direct selling costs
• Sales commissions
• Payment processing fees
• Freight
• Certain aspects of marketing
• Direct labor

Fixed costs

After variable costs are deducted, fixed costs are usually next. These expenses typically do not vary with changes in revenue and are mostly constant, at least within the time frame of the operating budget.

Examples of fixed costs include:

• Rent
• Head office
• Insurance
• Telecommunication
• Management salaries and benefits
• Utilities

Non-operating expenses

Non-operating expenses are those that fall below Earnings Before Interest and Taxes (EBIT) or Operating Income.  Examples of expenses that may be included in a budget are:

• Interest
• Gains or Losses
• Taxes

Non-cash expenses

An operating budget often includes non-cash expenses, such as depreciation and amortization.  Even though these expenses don’t impact cash flow (other than taxes), they will impact financial reporting performance (i.e the figures a company reports at the end of the year on their income statement).

Capital costs in an operating budget

Capital costs are usually excluded from an operating budget. The term operating refers to a statement of operations (income statement) which does not include capital expenditures.

Financial Budget

A budget helps an organization allocate the resources of the company to different departments and activities and manage the cash flows of the business in an effective way. There are many types of budgets. One of them is a financial budget.

The financial budget is one part of a business’s master budget. The second part of the firm’s master budget is the operating budget. The master budget is the financial portion of the business’s strategic plan for the near future. The strategic plan for the business maps out the firm’s planned financial activities for the next five years.

The purpose of the financial budget is to estimate the firm’s cash budget, capital expenditures, and balance sheet line items like assets, liabilities, and owner’s investment. The financial budget is the last budget to be developed by the firm every year since all other budgets, like the individual budgets in the operating budget, are necessary first. The financial budget helps the firm by allowing it to calculate net profit when the budget process is complete.

The capital expenditures budget is the first budget of these three budgets to be prepared within the framework of the financial budget. The information from this budget is needed for both the cash budget and the budgeted balance sheet.

Capital expenditures are fixed asset expenditures. Fixed assets are equipment or facilities needed for a business to operate. These expenditures also include maintenance for these items. While there are businesses that purchase larger amounts of fixed assets, most smaller businesses do not.

Small businesses tend to be more conservative in their capital expenditures since these types of purchases can be very costly. Many do not own the facilities they operate in, reducing capital expenditures.

While an expenditures plan for maintenance of the equipment is likely, a smaller business may lease, rather than own, their equipment. Consider depreciation and standard lifetimes of your equipment when designing your capital budget if you own your plant and equipment.

Different Sections of a Financial Budget

Budgeted Balance Sheet

The budgeted balance sheet comprises many other budgets. The major component of this budget includes the production budget and its associated budgets.

Cash Budget

The cash budget contains information on the inflows and outflows of the business. On the other hand, the cash flow of the business continues changing and with that, the cash budget should also change. Making a cash budget is a dynamic process, not a static one. There must be an immediate reflection of any change in the cash flow in the cash budget of the business.

Capital Expenditure Budget

As the name suggests, the capital expenditure budget relates to expenses related to plant and machinery or any capital asset of the business. This budget determines the expenses that would be incurred if an existing plant is replaced or any new machinery is bought. Factors like depreciation, cost of the plant, life of the machinery, etc. are taken into account when preparing the capital expenditure budget.

Financial Budget Plan

The financial budget plan is comprised of the following steps:

• Calculate the expected outflow
• Calculate the expected inflow
• Set the targets
• Keep track of components in the budget
• Divide the expenses into different categories
• Set up the ledger

Capital Budgets

Capital budgeting involves choosing projects that add value to a company. The capital budgeting process can involve almost anything including acquiring land or purchasing fixed assets like a new truck or machinery.

Capital budgeting is the process a business undertakes to evaluate potential major projects or investments. Construction of a new plant or a big investment in an outside venture are examples of projects that would require capital budgeting before they are approved or rejected.

Corporations are typically required, or at least recommended, to undertake those projects that will increase profitability and thus enhance shareholders’ wealth.

However, the rate of return deemed acceptable or unacceptable is influenced by other factors specific to the company as well as the project.

Objectives of Capital budgeting

Capital expenditures are huge and have a long-term effect. Therefore, while performing a capital budgeting analysis an organization must keep the following objectives in mind:

Capital expenditure control

Selecting the most profitable investment is the main objective of capital budgeting. However, controlling capital costs is also an important objective. Forecasting capital expenditure requirements and budgeting for it, and ensuring no investment opportunities are lost is the crux of budgeting.

Selecting profitable projects

An organization comes across various profitable projects frequently. But due to capital restrictions, an organization needs to select the right mix of profitable projects that will increase its shareholders’ wealth.

Finding the right sources for funds

Determining the quantum of funds and the sources for procuring them is another important objective of capital budgeting. Finding the balance between the cost of borrowing and returns on investment is an important goal of Capital Budgeting.

Cash flow forecasting is the process of estimating the flow of cash in and out of a business over a specific period of time. An accurate cash flow forecast helps companies predict future cash positions, avoid crippling cash shortages, and earn returns on any cash surpluses they may have in the most efficient manner possible.

Cash flow is the amount of money going in and out of your business. Healthy cash flow can help lead your business on a path to success. But poor or negative cash flow can spell doom for the future of your business.

If you want to predict your business’s cash flow, create a cash flow projection. A cash flow projection estimates the money you expect to flow in and out of your business, including all of your income and expenses.

Typically, most businesses’ cash flow projections cover a 12-month period. However, your business can create a weekly, monthly, or semi-annual cash flow projection.

Advantages of projecting cash flow

Projecting cash flows has many advantages. Some pros of creating a cash flow projection include being able to:

• See and compare business expenses and income for periods.
• Predict cash shortages and surpluses.
• Determine if you need to make adjustments. (e.g., cutting expenses)
• Estimate effects of business change. (e.g., hiring an employee)
• Prove to lenders your ability to repay on time.

Forecasting:

Determine Your Forecasting Objectives

To ensure you see actionable business insights from a cash flow forecast, you should start with determining the business objective that the forecast should support. We find that organizations most commonly use cash forecasts for one of the following objectives.

• Short-term liquidity planning: Managing the amount of cash available on a day-to-day basis to ensure your business can meet its short-term obligations.
• Interest and debt reduction: Ensuring the business has enough cash on hand to make payments on any loans or debt they’ve taken on.
• Covenant and key date visibility: Projecting your cash levels for key reporting dates such as year, quarter, or month-end.
• Liquidity risk management: Creating visibility into potential liquidity issues that could arise in the future so you have more time to address them.
• Growth planning: Ensuring the business has enough working capital on hand to fund activities that will help grow revenues in the future.

Choose Your Forecasting Period

Once you’ve determined the business objective you hope to support with a cash flow forecast, the next thing to consider is how far into the future your forecast will look.

Generally, there’s a trade-off between the availability of information and forecast duration. That means the further into the future the forecast looks, the less detailed or accurate it’s likely to be. So, choosing the right reporting period can have a big impact on the accuracy and reliability of your forecast.

• Short-period forecasts: Short-term forecasts typically look two to four weeks into the future and contain a daily breakdown of cash payments and receipts. As you might expect, short-term forecasts are often best suited for short-term liquidity planning, where day-to-day granularity is important to ensure a business can meet its financial obligations.
• Medium-period forecasts: Medium-term forecasts typically look two to six months into the future and are extremely useful for interest and debt reduction, liquidity risk management, and key date visibility. The most common medium-term forecast is the rolling 13-week cash flow forecast.
• Long-period forecasts: Longer-term forecasts typically look 6–12 months into the future and are often the starting point for annual budgeting processes. They’re also an important tool for assessing the cash required for long-term growth strategies and capital projects.
• Mixed-period forecasts: Mixed-period forecasts use a mix of the three periods above and are commonly used for liquidity risk management. For example, a mixed period forecast may provide weekly forecasts for the first three months and then on a month-to-month basis for the next six months after that.

Choose a Forecasting Method

There are two primary types of forecasting methods: direct and indirect. The main difference between them is that direct forecasting uses actual flow data, where indirect forecasting relies on projected balance sheets and income statements.

Choosing the right forecasting method depends on the cash flow forecasting window you selected above, as well as the kind of data you have available to build your forecasting model.

Source the Data You Need for Your Cash Flow Forecast

Direct forecasting provides the greatest accuracy and works for the majority of business objectives that companies build forecasts to support. Therefore, we’ll focus on where to find actual cash flow data for your forecast in this section.

The right places to source cash flow data for your forecast ultimately depends on how your business manages its finances. But, generally speaking, most of the actual cash flow data you’ll need to build your forecast can be found in bank accounts, accounts payable, accounts receivable, or the accounting software you use.

• Your opening cash balance for the forecasting period: This is normally taken from the most up-to-date and accurate reflection of current positions.
• Your cash inflows for the forecasting period: Anticipated sales receipts from within the forecasting period are usually the primary source of data for your cash inflows. Other types of cash inflows to consider including are intercompany funding, dividend income, proceeds of divestments, and inflows from third parties.
• Your cash outflows for the forecasting period: We recommend capturing wages and salaries, rent, investments, bank charges, and debt payments. But you can include anything that’s relevant to your business.