Tips for creating an effective budget
Budgeting is an activity that every company should carry out at least once per year. Not doing this leaves the business with less control and no focused spend structures. Overspend and underspend can lead to confusion, lower confidence, and host of other weaknesses.
But what exactly does a budget look like, and how does it more specifically help a business's pursuit of success?
In this article, we highlight different types of budgetary control, discuss how to build an effective budget, and explain how software can enhance your budgeting process.
Read on to discover some useful tips…
What exactly is a budget?
A budget is quite simply a way of sticking to a predetermined level of spend during a particular period of time. In order to decide what the budget will be, a company will usually need to estimate the financial incomings and outgoings within that timeframe. It’s then easier to judge what can be spent on each function, and if there’s any left over to invest in aspects like infrastructural improvements.
A manufacturer’s costs, for example, can be broken up into the following categories:
- Direct material costs – The cost of any raw materials that are purchased to produce the items that will be sold.
- Direct labour costs – The cost of physical production, which includes the wages paid to employees involved in this process.
- Manufacturing overheads – Any other costs that are needed to keep the company running, such as energy bills, rent, and machinery maintenance.
Income would largely be made up of sales that take place throughout the year.
How do budgets help companies?
By having an upper boundary for what can be spent, companies should be safe from the perils that come with overspending. Whilst detailing all incomes and expenses, you’re likely to uncover some useful insights too.
For example, a selling business will learn exactly how much it costs to produce each unique item in their inventory. This information should influence how much is charged for each product, as they'll want to make a reasonable profit.
With greater visibility, it's more possible to cut costs too, as you may discover you’re spending too much on certain processes. Having a budget in the first place helps businesses to strive towards greater efficiency (as they’ll do all they can to fall within the budget).
A budget acts as a concrete target to aim for, meaning all employees will be working to reach a common goal. Not only this, but cashflow can also be improved as a result of enforcing tighter measures around spend.
What are the types of budgetary control?
There’s not a single template for budgeting. It’s useful to be aware of some of the most well-known budget types.
This is possibly the most well-known budget, as it covers everything a company does (accounting for all their separate departments).
Some companies may use more specific budgets for individual functions (some of which we’ll cover below), others will just have a master budget (or a combination of low-level and high-level budgets).
It really depends on what works for you. The master budget is arguably the most important, as it seeks to improve your overall financial performance.
This budget type is a means of controlling spend around operational costs only. This includes many of the physical activities that are relevant for those in manufacturing, such as producing and selling items. Any costs or gains that have previously occurred as a result of these processes would help to shape the operating budget.
Cash flow budget
A cash flow budget can be very helpful, as it can provide companies with an estimate of how much fluid cash they should have on hand at any time. This is an important metric to have in place, as it is this cash that must be used to meet financial obligations (such as paying suppliers or fixing faulty machines).
These payments can’t be made using income you’re expecting to make in six months (or with value that is tied up in fixed assets). Without control or visibility of cashflow, you could end up in a position where bills can’t be paid on time.
A static budget should theoretically be one of the easiest budgets to stick to, as it is money put aside for fixed costs. Any costs or income that have already been agreed and are certain to happen (such as the rent you pay for your workspace) should be used to formulate this budget.
It may seem irrational to have a budget for something that is seemingly fixed, but it’s always possible that something could still change, so the static budget can be useful for seeing to what degree anything varied from the expected transactions.
This budget won’t incorporate fluctuating aspects, such as the number of sales you’re making throughout the year. There can certainly be value in separating the budgets that are put aside for fixed and non-fixed transactions.
Unlike a cash flow budget, a financial budget will take into account any value that is locked away in aspects such as assets or shares. This can include any remaining capital the company has outside of daily operations.
It can be important to have an estimation and a target for what this capital figure should be, as it can indicate your overall financial health (and may be needed to cover any financial liabilities).
How to prepare a budget
Choose the right budget type
It’s important to put in place the right type of budgetary control, as this provides a foundation when beginning the budgeting process. You should choose the model that is best suited for your needs.
As mentioned, the master budget may be most appropriate, as it covers all bases. Then you can break it down into more specific budgets if needed, to gain a more detailed picture.
It’s important to account for absolutely every income and outgoing your business encounters when building a budget. There may be some obscure costs that you think aren’t worth using in your calculations.
But by leaving anything out, you’re ensuring your data is inaccurate, and therefore the budget put in place won’t control spend in the desired ways.
In order to achieve this, you must have an effective strategy for monitoring all financial data, and you must build a culture in which employees record this information like it’s second nature.
Draw from previous performance
You should also ensure you analyse the financial performance of previous years. Not only will you get a general idea of how much you can safely spend in a typical year, but you may also notice patterns that help to shape your budget for the forthcoming year.
It doesn’t really make sense to keep the budget the same for the entire annual period if you can clearly see that things are playing out unexpectedly as time progresses. Being flexible can be a useful trait for businesses in many regards, and it’s no different with budgeting.
You may notice that you are overspending after a few months have passed, at which point you could counteract this by making the budget tighter.
Equally, you could see that anticipated costs are lower than expected, at which point the budget could be raised, and you may have the funds to invest in something that aids performance.
Use your data to its full potential
As there can be a lot of guesswork with putting a budget in place, many will be overly cautious to counteract potential risks. But if you harness the full power of your data, there is less conjecture and more informed predictions. As a result, you can create a budget that is just right.
You have access to a vast array of financial data, both past and present. With the right tools, you can extract value from these numbers and make highly accurate forecasts. This may involve utilising a smart system to analyse this information, rather than relying solely on employees (who will take longer and make more mistakes).
Hire the right people
When it comes to any task in the world of accounting (including budgeting), it’s important to have a highly skilled finance team. You should employ individuals that are in the loop with the latest industry trends, and are also adaptable in the face of new performance-enhancing technologies.
Use accounting software
In terms of the tools you can use to assist with budgeting, there’s always the option of a spreadsheet. But the most transformational way to build an effective budget is to use dedicated accounting software.
Which accounting software to use
The most obvious place to start in your search for accounting software is to find one with the appropriate budgeting functionality to complete the desired tasks.
Does it allow you to seamlessly create and upload budgets? Can you report against actuals and variances? The right system will lead to more control over spend, increased visibility of financial performance, and higher chances of reaching financial goals.
You should also consider the wider accounting capabilities of any potential system. Does it make use of a unified ledger and a hierarchical accounts structure? Does it include features for customer / supplier invoicing, asset management and multi-currency transactions?
The right accounting solution will empower your finance team, so they can monitor all transactions with ease, whilst making use of more accurate data. It should allow them to extract value from this information, which can then inform the budget. Time will be saved on these tasks too, with efficiency being increased and less energy being exerted.
Advanced’s Manufacturing Software has all the functionality described above, and has the added advantage of being cloud-based too. Perhaps its most beneficial characteristic is that it serves as a unifying business management solution.
Accounting is just one aspect of it, alongside features for payroll, stock control, production planning, contact management and e-commerce. The instant connection it creates between your departments leads to an environment of cohesive and consistent data.
With these functions being fully integrated, you gain a level of automation, which allows you to comfortably grow your operations. The improved quality of data, combined with powerful reporting features, leads to transformational predictions that can govern key business decisions.
If you’re looking to enhance your business’s budgeting process, read more about our Manufacturing Software (which is perfect for small to medium-sized manufacturers).