Budgeting techniques for small business owners

Budgets are an important and useful tool for organizations. Enterprise level organizations invest heavily in financial planning and analysis departments. The small business owner may not require a full time budgeting team, however it is important for small business owners to invest some time and invest in their accountant’s time on the budgeting process. Many business owners guide their employees and check current performance of their organization by just using their instincts (gut feeling). At times though, the gut feeling can be fogged by unrealistic expectations; so it is really important for business owners to have an objective tool / map to back up their instincts and protect their investment.

The budgets and ongoing Actual vs Budget analysis can act as such a guide and check that aids business owners in both directing their employees and reviewing their employees performance towards the organisation’s goals. Below are examples of techniques that business owners and their accountants can use to build budgets:

Incremental Budgeting:

Using Profit and loss (Income Statement) reports generated from their accounting software, broken down by month; business owners can mark up their budgeted revenue and costs for the next accounting year. Advantages of this technique are that it is quick and time-wise, cost effective method. A disadvantages of using this technique is that if the organisation is looking for growth, marking up will not take into consideration, the fixed costs and marginal costs associated with generating a revenue; so by just increasing costs by expected revenue growth may not give true reflection of the costs associated with growth, Zero based costing.

Zero based costing: 

Zero based costing is at the opposite end of the spectrum of Incremental Budgeting. Zero based costings assume the business is starting from scratch by using costs, generated from current market values. An advantage of this technique is that will be a more up to date map than one generated using Incremental Budgeting techniques. Though it is time consuming to collate the information; additional benefit to using this technique is that it encourages organisations purchasing department to collate market prices. This in turn encourages them to review their supplier contracts more regularly and assess if their supplier contracts are competitive.

Activity Based Budgeting
Activity Based Budgeting focuses on expected sales and calculates backwards the costs associated with doing activities that generate that sale. Costs are apportioned by product, service and indirect costs (such as headoffice costs) are put back in at product, service level. It is also a good method to identify loss making products, services streams and activities associated with these. Before attempting to implement a budget, business owners must gain buy in from department heads in the budgeting process at department level, by identifying costs that department heads can, or cannot control. Otherwise there is a potential of department heads becoming de-motivated because their performance is measured on costs they cannot control.

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