Budgeting process – the value of linking it to your plans

Happy Friday all!  I was going to post this on Monday, but it is Independence Day weekend here in Zed and I have every intention of enjoying the long weekend. But that does not mean I stop blogging.  It has been an interesting week or two, and I am tempted to deal with the going ons, but let me focus on bringing to you, part two of my earlier blog. I’m sure you recall that I was giving some insights about making the most of your budgeting process.  We laid down the three fundamental principles that you need to keep in mind, namely:

  • Profit or cost centres – your budgets should focus on these. If you are doing a personal budget, you might have 1 or more cost centres (home expenses, office expenses, social and entertainment, etc). As an organisation, you might have single sources of income and various cost centres, or many revenue lines and related cost centres.
  • SMART objectives – we are all aware that objectives should be Specific, Measurable, Attainable, Realistic and Time-bound.
  • Synergies and unity of purpose – budgets should achieve this at all times; be it in a business or in your home.

I also shared the first four steps around setting out your long-term goals, after which you, as the entrepreneur or senior manager breaks them down into components. With the benefit of knowledge of the business, you need to further breakdown your components into variables. Once you have done this, you can begin to focus on the data that is available around each of the variables.

The reason I started with the long-term goals, is because budgets should be part and parcel of your long-term plan. No budget should be used to simply move from point A to B. It should be moving you from point A to B as a way to facilitate your journey to C then D. Fortunately, once you decide to move to D, that decision-making process is not something you need to undergo every year. You can tweak your plan or find a different route, but getting to D remains your goal. You will remember in an earlier blog, I spoke of consistency. Not confusing ‘flexibility’ with ‘fickleness’.

So… once you have reached a position where you are clear on the variables and the available data, you can move to the next step. This part is where most people find themselves getting involved – bringing the variables together as a budget. Previously, all you had was data. You knew how many pre-paid vs post-paid customers you had. As retailer, you knew how much of your sales were via lay-bye versus direct sales. As a distributor, you knew how many units you sold per region. Now, you pull all these together and assemble it into information.

Now I will get a little technical here. This is a key part of the conversion of a plan, into something you can actively measure with Dollars and Cents or Kwachas and Ngwees.  One of your variables, needs to be ‘currency based’. For example, if you are a retailer and you know how many customers you had; you can take the total revenue and divide the two to get an average spend per person.  One could argue that the sales per each customer gives more detail, as opposed to an average price.  However, one must always ask themselves whether more detail is equal to more information….

Anyway, with the average revenue, you can set objectives for each region to increase revenue through an increase the number of customers or a higher average price.

How would the above work? Well, if we take the same retailer, he could set an object to increase revenue by 10%. The retailer will achieve this, say, by increasing the number of customers by 7% and 3% from higher average spending.  You could then proceed to target increase average spending, by either increasing the prices or getting a better product mix. This goes on and on, but the senior managers need to dedicate sufficient time to this.

In determining which variable needs to move in which way, the senior management team, then take the next step of amalgamating the individual budgets/ components into one document.  Remember, your budget is only as good as the whole and how well it links back to step 1 Where you want to be. For those of us who love numbers, it is very easy to focus on the variables and ignore the link. We start saying things like ‘If we can increase the average spend by just 3%, we can grow the company by 23%!’

That statement contravenes quite a few basic philosophies of mine. Firstly, you are focusing on the short-term ignoring what the long-term agenda is (maybe you need to grow the customer base, by giving larger discounts).  It also promotes pursuit of an end-game as opposed to pursuit of the right actions (maybe the company has a lower average spend per customer, because the sales men are not motivated to sell high end goods).

Before I digress…. We were talking about amalgamating the individual parts into the whole.  Once this is done, the senior team must seat and ask themselves whether the complete picture talks to Step 1.

If the answer is ‘Yes’, you are good to go!

Only one thing remains – retain the information on the variables so you can use them to set up a mechanism for monitoring performance against budget.  Remember that the object of the budget, is to drive the right behaviours.  If you have agreed to increase the average spend by improving the product mix, you can monitor this on an ongoing basis.  Early in the process, you might find that trying to change the mix will negatively impact your volumes, so you decide to maintain the average spend, but target growth in customer.  The only way to properly monitor performance against budget, is to consciously recognise the variables you were working with and how each one is behaving.

The above is a general outline of the process of preparing a plan and quantifying that plan into a budget. All entities are different, but the overall structure remains generally the same.  Remember, 3K&L respects the individuality of each company and therefore we do not offer bespoke solutions. We engage, listen, react.  Talk to us to help you with your budget process.

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