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2015-07-23 12:10:07
Harvard Business Review Staff
July 20, 2015
You know it s important to weigh the costs and benefits before committing
resources. So what are the crucial strategies when preparing a budget? How can
you use past financial data to inform your assumptions? And how can you ensure
your budget will help you meet your strategic goals? This advice, adapted from
the book Finance Basics, will help you better understand how to create a useful
budget.
Budgets should be ambitious but realistic. Don t map out a budget that you can
t meet but don t underestimate the possibilities. Here s how to begin.
First, list three to five goals that you hope to achieve during the period for
which you are budgeting. For example:
Increase gross sales by 5%.
Decrease administrative costs as a percentage of revenue by 3 points.
Reduce inventories by 2% by the end of the fiscal year.
Make sure those goals line up with the organization s strategic priorities.
Next, figure out how you ll achieve them. (Remember that a budget is just a plan
with numbers.) How can you generate more revenue? Will you need more sales
representatives? Where can you cut costs or reduce inventories?
The smaller the unit you re focusing on, the more detail you need. If you re
creating a budget for a 12-person sales office, you typically won t have to
worry about capital expenditures such as major upgrades to the building. But
you should include detailed estimates for travel costs, telephones and
utilities, and office supplies. As you move up in the organization, the scope
of your budget will broaden. You can assume that the head of the 12-person
office has thought about printer cartridges and gasoline for the sales reps
cars. Your job now is to look at big-picture items such as computer systems and
to determine how all the smaller-scale budgets fit together.
Other issues to consider when you re preparing a budget:
Term. Is the budget just for this year, or is it for the next five years? Most
budgets apply only to the upcoming year and are reviewed every month or every
quarter.
Assumptions. At its simplest, a budget creates projections by adding
assumptions to current data. Look hard at the assumptions you re making. Let s
suppose you think sales will rise by 10% in the coming year if you add two more
people to your unit. Explain what you re basing that assumption on, and show a
clear connection to at least one strategic goal (in this case, it s probably to
increase sales by a certain percentage).
Role-playing may help you here. Put yourself in the position of a division
manager with limited resources and many requests for funding: Under those
circumstances, what would persuade you to grant a request for two additional
staff members?
Articulating your assumptions
Usually, budgeters take the previous year s budget as a starting point. If you
re the manager of the Moose Head Division at the fictional company Amalgamated
Hat Rack, for instance, you might look at the 2014 budget to get ideas about
how to increase revenue, cut costs, or both. (See the figure below, Moose Head
Division, Amalgamated Hat Rack. Note that the parentheses in the table
indicate unfa vorable variances.)
W150707_HBREDITORS_BUDGETEXAMPLE
Don t look only at specific revenue or cost line items, because revenue and
costs are closely linked. Instead, ask yourself what the budget shows about
last year s operations. As the table shows, the Standard Upright and the Moose
Antler Standard exceeded sales expectations in 2014. Perhaps it would make
sense to increase your sales projections for those products, particularly if
your sales reps are optimistic about the prospects for more sales. The Standard
Upright might be a particularly good choice, since it beat its 2014 projection
by 9%. Could you increase the anticipated sales for this model by 5% or 10% in
2015? How much more would you have to spend on sales or marketing to achieve
this increase? To make the decision, you ll need as much data as you can get
about pricing, competitors, new sales channels, and other relevant issues.
Alternatively, you might plan to eliminate some products. The Electro-Revolving
model, for example, is faring poorly. Would it be better to cut this line and
promote the newer Hall/Wall model? That would eliminate $81,250 in sales, but
the Electro-Revolving is expensive to produce, so discontinuation might not
have much impact on the bottom line.
Other questions to ask yourself:
Will you keep prices the same, lower them, or raise them? A price increase of
3% might offset the budget s 2014 sales shortfall, provided that it doesn t
dampen demand.
Do you plan to enter new markets, target new customers, or use new sales
strategies? How much additional revenue do you expect these efforts to bring
in? How much will these initiatives cost?
Will your cost of goods change? For example, perhaps you plan to cut down on
temporary help and add full-time employees in the plant. Or perhaps you hope to
reduce wage costs through automation. If so, how much will it cost to automate?
Are your suppliers likely to raise or lower prices? Are you planning to switch
to lower-cost suppliers? Will quality suffer as a result? If so, how much will
that affect your sales?
Do you need to enhance your product to keep your current customers?
Does your staff need further training?
Are you planning to pursue other special proj ects or initiatives?
Articulating your answers to questions like these en sures that your
assumptions won t go unexamined. It will help you create budget numbers that
are as real istic as possible.
Quantifying your assumptions
Now you need to translate your assumptions and sce narios into dollar figures.
Begin with last year s budget and make the changes that fit your plans. If your
entire staff of 12 needs sales training, for instance, find out how much the
training will cost and add in that amount. Ask your coworkers for their ideas
about costs as well. And consult the websites of trade associations or trade
publications for data on indus try averages.
Because your budget must be compared and com bined with others in the
organization, your company will probably provide you with a standard set of
line items. When you ve filled those in, take a step back: Does this budget meet
your unit s goals? It s easy to overlook big-picture goals as you get into
line-by-line details. Is your budget defensible? You may be per fectly happy
with it, but you ll need to win over the budget committee. Once again, push
your assump tions. Could you do with one extra staff member instead of two? If
not, be sure you can make a good argument as to why not.