Businesses, big or small, are advised to prepare a budget as a tool that will help the entrepreneur or his managers plan for the future and ensure the business remains viable and sustainable over the long term.
The budget is a detailed plan showing how resources will be used during a given period of time – say six months, one year, two years.
The benefits of budgeting, according to SME Insights (March-April 2007), are many and these include the following:
- A budget helps the manager decide how to allocate the resources of the business which, for small enterprises, are typically limited. For instance, if excess cash was available and the manager is choosing between paying off high-interest loans or investing in additional inventory to increase revenues, he may project budgets for both scenarios and pursue whichever option has a more positive effect on the bottom line.
- A budget provides standards for evaluating performance. Targets are compared with actual results and differences or variances between the two are identified and analyzed so that the company can take corrective action. For example, if actual sales were significantly below the budgeted level, the manager is alerted to study the possible reasons for the shortfall.
- A budget, while being prepared, forces staff with different responsibilities to work together toward achieving common goals. Whether they are in sales, human resource or production with different goals, working on the budget will help unify seemingly opposing goals so that eventually personnel find a way to achieve whatever is best for the company.
- The budget also serves as a communication tool for exchanging information about company goals and achievements.
- Finally, a budget, if used properly, provides the manager the motivation to work harder to achieve the projected results.
It must be remembered, however, that a budget has its limitations. First of all, it is dependent on assumptions on forecasted sales revenue for example, drawn up from external factors such as the economy and the competition. As such, most budgets tend to oversimplify the business situation the company faces.
To be truly useful, a budget must be prepared with full management support and the involvement of all company personnel. It must not be done as a mere number-crunching activity.
Although the budget can serve as a motivational tool as well, the opposite effect may be achieved sometimes. This is true when unrealistic targets are set, thus dampening people’s enthusiasm.
All concerned must remember that budgeting is not an exact science but rather one that requires continuous updating and revisions as conditions change and new information come in.
(Watch out for a sequel on how to prepare a budget.)