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Amazingly simple way to manage your financials, thanks to the Master Budget Series
Every year you have to set out time to do your annual financial budget for the next year. You could have encountered serious expenses this year and not adjusted or taken into consideration your financial budget for the current year. This can impact your business cash flow position and you won't know if your money is working for you or not.
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Three common budgeting mistakes people make
1. Incremental budgeting;
2. There's a fine line between control and planning
3. 'Chiselled-in-stone' budgets.
Mistake #1: Incremental budgeting
Take last year's budget and add a percentage, which is usually related to inflation.
Graziella wants to prepare a budget for 2016. She believes inflation for the 2016 financial year will be 6%. She takes her 2015 budget and adds 6% to each line item, except depreciation which is a fixed cost. This is the result:
This isn't a useful budget, so what benefit could Graziella derive from this document? Would she see that sales will increase by 6%? Will the cost of ingredients increase by 6%?
What's the problem with incremental budgeting?
You can see the problem with just increasing last year's budget by a fixed amount – it doesn't relate to reality. Remember, inflation is not a single number – so don't treat it like it is. The South African Consumer Price Index is made up of a basket of more than 400 items, broken down into 12 major categories of consumer expenses, each one of which increases at a different rate.
So why do people perform incremental budgeting? Largely because they don't use the budget to manage or plan their businesses – so their budgets are not of any importance. They know they should have a budget, so they put together a random set of numbers.
Mistake #2: There's a fine line between control and planning
Don't use your budget to penalise your staff for not achieving targets!
Planning involves developing objectives and preparing budgets to achieve these objectives. Budgets allow you to anticipate problems to establish where potential strengths and weaknesses lie in your operations for the next year.
So, if you make the mistake of controlling your staff members too much with your budget, you could end up with a budget that doesn't help you to achieve any plans – because your staff members don't feel motivated to achieve your plans. Remember: Your budget is a control tool, not a control weapon.
If created a budget which shows that you can achieve the kind of profit you believe is appropriate, and if everyone who has any budget responsibility has agreed to their portion of the budget and there is general buy-in, you have a very powerful planning and control tool.
The planning has taken place now how do you control?
Prepare a comparison, at the end of each month, between your budgeted and your actual results. Sit in a meeting with all concerned staff and evaluate the budget compared with the figures you actually achieved. Was your planning good? What did you miss? Where could you do better? What needs to change in the budget going forward to take into account the actual results achieved?
Your control mechanism is now a planning control, not a performance control, and your staff will work with you in trying to achieve budgeted results and plan for the future.
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Mistake #3: Avoid having your budgets 'chiselled-in-stone'
The final problem with budgets is companies behave as if budgets are set in stone and can't be changed. Use your budgets for planning and for control and accept they can change as circumstances inside or outside the company change.
Jamo plans for 12 000 chairs a year. Imagine this: He suddenly receives a large order for 5 000 chairs in one month. 'Sorry, we can't do that,' says Jamo. 'It's not in the budget!' Of course he wouldn't do this! He'd take the budget and see how he could plan to increase production to account for the special order – possibly by changing other plans, possibly by working an extra shift. He would certainly try to understand the implications the new order has on costs and pricing, as well as his other customers.
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