by Merlin Hernandez

A budget is a financial plan that is based on an estimate of future income and expenses. Developing a budget begins with an estimate of future sales (sales forecast) in order to calculate the expenditure necessary to achieve those revenues. Sales forecasts predict sales volume for a particular period by comparing estimated future sales with the actual sales of the prior period. This would make the forecasted ending balance sheet for the prior budget period essential to developing the sales forecast as it brings important insights about trends and seasonal fluctuations, and can be a reminder of unexpected environmental determinants like rising unemployment levels, changing interest rates or credit market challenges.

The sales budget clarifies required product volumes, defines cost driver budgets, and helps to determine the best price at which to sell. The sales forecast responds to some basic questions:
– The number of different products the company plans to sell.
– The number of units of each product to be sold.
– The selling price of each unit.
The Sales Budget uses this information to determine the level of production required and at what intervals, the costs of bringing the product to market, and expected revenues for the period. Costs are broken down into an Operating Budget for variable costs and selling/administrative expenses, and a Financial Budget for fixed and capital costs as well as cash requirements. The sales forecast, therefore, drives the master budget in that it gives form to the sales budget and other cost driver budgets that lead to the development of operating and financial budgets.

Continuous Budget
The continuous budget is a valuable tool for better planning and performance measurements by factoring the changes that could affect sales projections in order to take preemptive or corrective action. A continuous budget strategizes by drawing from past performance within the period to adjust strategies for the future. But it applies the most recent information like economic factors, new technological applications or market changes for a new starting point to forecasting revenues. For example, a new competitive product on the market could determine a need to increase the advertising budget, offer new volume discounts to customers, or increase sales efforts, which would alter budget allocations and/ or revenue expectations, all of which are designed to mitigate possible revenue contraction.

Continuous budgeting does however, present moving targets that dictate a constant need to re-strategize ways to achieve them. But failure to accommodate environmental changes or changes in resource availability will mean that the budget remains in a vacuum and devoid of the up-to-date and realistic input that would inform corrective action and budgetary adjustment.

Control Management
A company that manufactures and sells a product may experience fluctuations in sales from month to month. A static budget would aggregate monthly production needs based on previous sales data and allocate a monthly production budget to reflect one twelfth of the overall allocation. This does not take into consideration months of high or low activity and would present a distorted view of production efficiencies or shortfalls – high-activity months would reflect cost overruns, and months of reduced activity would mean lower variable costs and not the ability of
the business to generate cost savings.

A flexible budget would link the observed revenue patterns of the previous budget to anticipated expenses for the new period and factor cost variances that reflect variable cost differentials for each month or quarter. Flexible budgeting is a useful feature in contingency planning for uneven levels of activity and is best used in the variable expense sub-section of the Operating Budget. It is the kind of budgeting that adjusts for changes in the volume of activity and is driven by expected cost behavior. It would be of greater benefit to a company than a traditional single value static budget which assumes a world of certainty and only factors one budgeted amount regardless of the volume of activity. A flexible budget is a more comprehensive accounting of the static budget’s cost variance and should be used in conjunction with continuous budgeting for enhanced tracking of variances and more effective control management.

There is need for greater flexibility in contemporary business environments which are characterized by the market volatility and technological changes that would favor continuous budgeting. Small businesses are particularly vulnerable but any type of business, small or large, can benefit from flexible budgets once there is a profit imperative with the need for cost controls. This would include companies engaged in manufacturing, service delivery or even non-profits that would still need to show their ability to generate a small profit as a mark of efficient management in order to maintain their funding.

But flexible budgeting can present control challenges as we target specific financial objectives that do not necessarily change because of threats in the environment. It comes down to the management of systems and processes for contingencies and short falls. The flexible budget is the practice of management by exception i.e. giving more attention to areas of significant variances for more efficient resource allocation and strategic implementation to achieve financial goals. The combination of continuous and flexible budgeting enables more intense contingency planning and adaptability as well as short term performance variance analysis that feed into better cost controls and profit projections.

Related articles on this blog
• Managing Small Business Financing
• Performance Metrics
• Resource Planning and Costing Systems

Merlin Hernandez is an entrepreneurial development and management consultant who operates mainly in the small and medium enterprise sector. For more information on this topic, please send enquiries to businesssolutions1168@gmail.com

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