Choosing a Budget Method
A budget is nothing more than a written estimate of how an organization — or a particular project, department, or business unit — will perform financially. If you can accurately predict your company’s performance, you can be certain that resources such as money, people, equipment, manufacturing plants, and the like are deployed appropriately.
Kinds of budgets
When it comes right down to it, you can budget any activity in your organization that has a financial impact. Two of the most common budgets are
- Cash budget: An estimate of a company’s cash position for a particular period of time.
- Operating budget: A business’s forecasted revenues along with forecasted expenses, usually for a period of one year or less.
Line items in your operating budget may include:
- Labor budget: The total labor cost to be expended for a set period of time calculated by taking every person in an organization, department, or project and multiplying the number of hours they are expected to work by their wage rates.
- Sales budget: An estimate of the quantity of goods and services that will be sold during a specific period of time.
- Production budget: A forecast thatstarts with the sales budget’s estimates of the total number of units projected to be sold, then translates this information into estimates of the cost of labor, material, and other expenses required to produce them.
- Expense budget: An estimate prepared for travel, utilities, office supplies, telephone, and many other common business expenses for a given period.
- Capital budget: The total costs and maintenance fees planned for your company’s fixed assets.
The best kind of budget is the one that works. You can choose from three key approaches to developing a budget:
- Top down: Budgets are prepared by top management and imposed on the lower layers of the organization. Top down budgets clearly express the performance goals and expectations of top management, but can be unrealistic because they do not incorporate the input of the very people who implement them.
- Bottom up: Supervisors and middle managers prepare the budgets and then forward them up the chain of command for review and approval. These budgets tend to be more accurate and can have a positive impact on employee morale because employees assume an active role in providing financial input to the budgeting process.
- Zero-based budgeting: Each manager prepares estimates of his or her proposed expenses for a specific period of time as though they were being performed for the first time. In other words, each activity starts from a budget base of zero. By starting from scratch at each budget cycle, managers are required to take a close look at all their expenses and justify them to top management, thereby minimizing waste.
Each has its advantages and disadvantages, and each approach can work well, although the pendulum is clearly swinging in favor of the bottom up approach.
Budget tricks of the trade
Budgets provide a kind of early warning system that, when compared to actual results, can inform you when something is going wrong that needs your immediate attention.
When your expenditures exceed your budget, you can do several things to get back on track:
- Review your budget. Before you do anything else, take a close look at your budget and make sure that the assumptions on which it is based are accurate and make sense in your changing market. If your market is growing quickly, you may need to adjust up your estimates. Sometimes, it’s the budget — not the spending — that is out of line.
- Freeze spending. One of the quickest and most effective ways to bring spending back in line with a budget is to freeze expenses such as pay raises, new staff, and bonuses.
- Postpone new projects. New projects, including new product development, acquisition of new facilities, and research and development, can eat up a lot of money. However, if you are too zealous in curbing spending when you need to develop new products or services to compete, the result can be disastrous for the future growth and prosperity of the company.
- Lay off employees and close facilities. This is the last resort when you’re trying to cut expenses. Although these actions will result in an immediate and lasting decrease in expenses, you also face an immediate and lasting decrease in the talent available to your organization. Productivity and morale of remaining employees may also suffer.