When creating the budget, there are certain business issues that need to be examined in order to use the budget in the best manner.
To assist strategic development of the company, budgets should be examined in the context of the entire business strategy and the processes that udnerly each area of the business’ activities.
Examine the Market for the Coming Year
Examine the expected market in the coming year with current clients and contracts in mind. Any new business is good to list separately so that changes in current business are easier to understand.
Once revenues are determined, then it is best to examine what purchases and staffing are required in order to achieve these revenue levels.
- Are there significant changes in the labour market?
- Will there be additional (or fewer) staff required?
- Are there other changes, such as training requirements or certifications that any staff will be required to obtain? Or perhaps there is deregulation and this is no longer required?
- Will new business require additional sales personnel? And how will these pay structures look? Is there any difference from prior years? Why?
Naturally there will also be operating expense differences that need to be examined. If additional staff are being brought on then this can significantly affect fixed costs in areas such as rental (office space) requirements, telecommunications, office expenses, and there may be additional support required. Of course, if there is no change in staffing, then these changes are likely to be minimal and should really be in line with inflationary changes for each items particular expense.
Are Targets Being Met?
There should be a historical or industry benchmark that you can use as a guideline on the ratios of costs to expenses as well as net income. For example, in some industries it is known that direct costs (also called cost of sales or cost of goods sold) are 50% of the revenue. Are these targets being met? What about the net income ratio? Many industries’ net income (before taxes) has a benchmark ratio, such as the well known 10% profit ratio for commercial construction. Is your company in line with the industry benchmarks? If not, then perhaps you should examine your budgets again. And if the budgets are in line with what you have been accomplishing, but you are still not meeting the industry benchmarks, then you may want to look at some of your business processes in order to assist meeting those targets. Budget for the industry benchmarks and see what you should be accomplishing.
Not to be Used for Bonuses
It’s not a good idea to use only budget targets to determine management bonuses. Such incentives should be based on performance, not reaching arbitrary targets. It is a common problem in corporate business to use reaching budget targets as a way to determine bonuses. This ends up being a huge incentive for managers to fudge numbers and lie about their budgets. It can even lead to other disastrous events in business planning. Find other methods to determine management pay, and you will be better off and receive more co-operation from managers and staff during the budgeting process.