Two javelin throwers who have crossed the 75-meter mark are aiming for the Olympics to be held in three years. Mr. A aims to cross the magical 90-meter mark at the latest in the home competition held a month before the Olympics. Mr. B's main goal is exactly the same, but in addition, he specifies annual, quarterly and monthly milestones. To achieve the milestones, Mr. B creates a detailed training program with his coach.
Which javelin thrower do you think finds it easier to adjust their training when they notice something isn't working as expected? Which athlete finds it easier to learn from mistakes? Which do you believe is more motivated during the training season? From which athlete could we learn more about profitable business?
In this article, I create an illustrative overview of the budget, one of the company's most important tools. You will learn what a budget consists of, how it is built, and how it should be managed.
Sub-budgets
The javelin thrower's training program is a metaphor for the company's sub-budgets. Sub-budgets build the big picture and help understand what is possible to achieve and what the realities are.
The most common way to create sub-budgets is to divide them to cover sales, variable costs, marketing expenses, fixed costs, and investments. From the totality of sub-budgets, a cash flow statement is compiled and the development of the company's cash is examined.
So let's start with the sub-budgets.
1. Sales budget
Example company X's main business is software sales, which depends on the number of salespeople. The selling price of one software is €50/month. Each salesperson is expected to sell twenty software units per month from September to May and ten software units per month from June to August. If the company currently has three salespeople and operations start in January, the sales budget looks like the result shown below.
2. Variable costs budget
Variable costs in budgeting mainly refer to costs related to the sold service or product. Direct variable costs are often purchases related to the service or product. In our example, we assume the company buys the software for resale at €20/month. Variable costs can thus be estimated based on the software sold.
3. Marketing budget
Marketing costs specifically refer to all costs planned for marketing. Marketing costs are convenient to divide on a monthly basis due to seasonal variations and cash forecasting. Our example company invests most in Google advertising from September to May.
4. Fixed costs budget
Fixed costs refer to costs that do not depend on the products or services the company sells. These include fixed salary, related personnel costs and accruals. Let's assume the company pays salespeople a salary of €3,000 per month according to the employment contract. Each employee accrues 2.5 days of vacation per month.
5. Investment budget
Investments refer to allocating money to intangible or tangible assets that are expected to generate income for the company usually for more than 12 months. In our example, the company purchased quality computers for the salespeople right at the beginning of January, which are estimated to last more than three years. The acquisition cost of the computers was €10,000 in total, and a 25% residual depreciation rate approved by the tax authority for machinery and equipment is applied.
Budget scenarios
As the most observant have already noticed, our example company's cash runs quite tight before operations break even. If something negatively surprising were to occur in the first year of operation, the company would likely be in a cash crisis. Conversely, if something positively surprising were to occur, it's worth preparing for that too. For the main budget prepared from the sub-budgets, it makes sense to create best and worst case scenarios in addition to the neutral scenario. They help prepare for unexpected situations.
Forecasts
Like any javelin thrower, a company must also learn from its mistakes and optimize its operations to succeed. Imagine that after the first three months, it appears that the annual budget will be exceeded or underachieved. Thanks to forecasts, the remaining period can be updated to match the current situation and necessary measures can be planned well in advance.
By creating shorter-term forecasts alongside the annual budget, the company can thus monitor the development of its financial situation more closely and react faster. However, the annual budget should be kept as is to evaluate the achievement of larger milestones.
How
Top-down and bottom-up budgeting
Budget preparation in companies is usually led either top-down or bottom-up. In the former, company management sets financial targets, operational goals, and metrics, which are delivered to the executing party. In the latter, more participatory model, the direction is reversed.
If every salesperson in the company could budget their own sales for the coming period, the budget would be bottom-up. To encourage salespeople, the company could create a cost center for each in accounting, from which the salesperson could easily view their budget performance and update their forecasts as needed.
Monitoring actuals and comparing to budget and forecasts
Comparing the actual income statement and balance sheet to manually prepared budgets quickly becomes laborious and frustrating. A popular alternative is the latest financial management and reporting software, where actuals are automatically updated in the software.
Tracking actuals has been made so effortless that it can be done by anyone with access rights. The budget and its variances can be quickly read from concise visual graphs and charts.
Some financial management and reporting software also offers companies the ability to customize an interface tailored to their specific needs. Through it, for example, management can at a glance monitor each salesperson's sales and gross margins as well as the most important KPIs for the company's business.
Finadeck helps with budgeting
Finadeck's AI-powered SaaS software is designed to help companies with consolidation, income and balance sheet budgets and forecasts, cash flow forecasting, and BI reporting.
