Mechanism to predict and manage organization’s future profit
Budget is one of the best practice in the area of financial management. According to me, budget is an integral part of running any business may it be small, medium or big. Budgeting helps organization in controlling their spending, track all expenses, gives priority and more importantly it communicates with people regards to what is essential and what is not.
To simplify, budgeting for organization is as simple as having your pocket money when you were in hostel during your college days. You spend your pocket money for the things which matters the most, and for rest you plan later. Budget always helps organization in being more organized, and avoid feeling financially overwhelmed when the things don’t go as per plan. Creating budget is challenging, but not difficult, understand that no budget is perfect, saying, the more organization work on their budgeting practice, the more logical and mature it becomes.
In this blog, let us walk you through high level steps on how to create budget and what organization can do post creating budget.
Steps in creating and managing budget
Identification of revenue and its sources
While developing a budget, the first step is to identify what revenue organization can achieve in respective financial year. Identifying revenue shall be based on past history, market trend, and what minimum organization can achieve with current infrastructure and eco system on hand, more of a realistic revenue figure. It is essential not to mix achievable revenue with the sales target, since sales target generally gets decided to push for more and more. Here, organization should consider conservative revenue which it can achieve.
Identification of all expenses
The first steps in identification of expense is getting to know your direct and indirect expenses. Direct expenses are those which are directly linked with your making of the product, such as raw material, consumables, packaging, tools & hardware, power & fuel, and labour and wages (We are taking a manufacturing organization as an example). Expense of this to be identified based on organisation past history in comparison with the revenue. This expenses majorly are variable expense which gets plus or minus depending on the production OR sales volume.
Once direct expenses are identified, work on knowing your indirect expenses which are generally fix in nature and does not change majorly in comparison with direct expenses regardless of your production or sales volume. This indirect expenses includes but not limited to salary & wages, rent, legal & professional fee, administrative expenses, and many more.
During identification of expense, it demands good amount of patience and a dedicated strong member who can take initiatives. To know some expenses, the member has to meet with various internal stakeholder of the organization to understand what are their plans and logic for projecting expenses.
Once expenses are identified, bifurcate those into fixed and variable, some component in direct expense can be of variable, and vice versa depending the nature of expenses. This is vital considering the next step which is knowing breakeven of the organization.
Identify breakeven point
Breakeven becomes the first milestone once budget gets executed. Breakeven is nothing but knowing when organization will be at no profit / no loss moment during their journey. To identify breakeven organization has to divide their fixed cost with difference of sales price per unit minus variable cost per unit. This is where organization can come at knowing minimum revenue which is required for breakeven and if it get divided with average rate then quantity can also be known.
It depends on organization to organization regards to on what aspect they would require to see breakeven, some organization requires to see on revenue basis and other on quantity. Also, yearly breakeven can be broken down into monthly so that focus communication can be done with the sales and marketing team to really get things moving
Upgrade existing eco system – Accounting Structure
Creating budget, executing budget, and monitoring all three stages, are in itself a daunting task. Once budget is created, organization may find out upgradation in their existing method of booking purchase and expenses. Organization may feel to change certain practice of booking expenses and their GL accounts. This helps organization to be more accurate and insightful of their spending. For example, in one of my project we segregated Power & Fuel expenses head into 3 bifurcation i.e. Electricity, Fuel for production, and fuel for vehicle considering there was huge chunk which was going. This changes required us to create new GL and training to accounting team along with purchase team, so that the creation of PO and booking of expenses would be in this pattern. It take quality time from the member who has taken the initiatives for budget.
Monitoring budget
The last steps in budgeting practice is monitoring the budget. Based on my experience, I have seen multiple organization who creates and executes budgets, but lacks in terms of how they should be monitoring the budget. In my recommendation, if budget monitoring is done manually, then the entire practice would end up in a huge mess later. Budget monitoring requires system generated data insights through which faster insights can be generated which helps in making decision at a rocket speed. Monitoring budget is essential, because it helps you not just to control but re-prioritize your spending. Ideally, monitoring shall be done on monthly basis against the budget you have planned.
Key notes to remember while working on budget
Always have some budget for contingency scenario – Saying identify expense area, which are high risk component. For example, in a way direct labour expenses are variable however, if business is forced to shut for 1 month (consider COVID situation),organization does not give daily wages, the labours would migrate considering they do not have fund to survive for a month. In this case, when operation restarts, organization would end up looking for labours instead of achieving their maximum productivity from 1st day of operations. Paying to them for certain period would makes more sense instead of losing productivity.
It is required to know capital expenditure planning – This helps organization in making fund flow
What next?
Once budget is prepared, the immediate next step is to create a fund planning, the budget will tell you where you can control your expenses but your fund planning would demand source of fund which eventually help you manage the overall inflow and outflow. I believe that neither budget and fund flow can give result in isolation, having practice of both simultaneously really gives value back to the organization.
At J.hirani & associates, we help organization achieving their objective within the framework of best practices and scalability. To know more about how to develop, execute and implement budget and fund flow visit our website or reach us at
Author:
Saurin Parikh, who has done Masters in International Business and Management Information System from Texas, is also a Certified Business Analyst. He started as a business analyst with Jagdish Hirani & Associated, is currently leading the core operations of transformation projects. He has wide experience in industries like home furnishing, diamond, tourism, food sectors etc. He is Observant, Conscious about facts, Patient, Positive, gives attention to detail and believes in total Completeness.
Success Mantra – “You have to touch ground (foundation) to make perfect organizations. Right methods with consistent approach are bound to yield results”
About J.hirani: J.hirani is a Strategic Transformation team which works as a growth partner for different organisations in various industries by providing services like Agile transformation, Scenario mapping, Strategic alignment, Balance scorecard, Digital transformation, Incubating new ventures, Operation excellence and Aligning human capital.
©J.hirani, Budget, June 2021. All rights reserved
