What is Budget and Budget Plans?
A budget is a table of expected revenue and expenses representing actions to be carried out in a given period like one to three years to achieve desired goals. It is a schedule for allocating resources to prioritized activities in the business plan and other day-to-day operations of the business. A budget is part of the business planning process and usually comes at the tail end of the planning process to allocate funds to any activity in the plan that needs funding. The business plan identifies priority activities to be carried out in year one, two, three and so on. The budget template is then used to allocate funds to these identified and prioritized activities spelt out therein to be carried out over the next one to three years. A budget is, with or without a strategic plan, prepared at the start of new business as well as at the beginning of each year for an ongoing business.
Purpose of a Budget
A budget has two chief purposes:
Template of revenue and expenditure: It is a platform for forecasting revenue and expenditure to enable a business owner or an individual to see in advance if the business will make a profit or not. The budget, therefore, provides a preview of how the business might perform, in the short and the long run, if the planned strategies and actions are implemented as planned. Seeing the possible outcome in advance allows the businessperson to make decisions on what to do or what to adjust now and aim at for desired results to be achieved. The budget is in this sense a tool for profit planning.
Using the desired rate of return on investment (ROI), the budget can be used iteratively to arrive at a future appropriate level of income and expenses targets that can deliver the desired ROI. The main elements of a budget namely revenue and expenses can be adjusted in an iterative budgeting (prioritization and allocating) process until a desired but realistic and attainable profit position that can be adopted is established.
Evaluation tool: The budget is a tool for monitoring spending and financial performance on a month to month basis and taking timely corrective actions as things move along. This control is implemented by comparing actual turnouts of events with their corresponding budgeted standards, item by item (budget line by line) and identifying the causes of deviations and taking remedial actions on the deviations.
A budget has only two main projections, income, and expenditure. Expenditure is usually in two parts namely recurrent or operating expenditure (OPEX) and capital expenditure (CAPEX). Capital expenditure is for acquisition or creation of durable assets for the business to facilitate the running of operations and which assets will be used in operations for at least a year and more. The cost of capital expenditure is not all expensed (i.e. the whole cost is not used in determining profit for the year) in one year. The cost is, instead, spread over its useful economic life through a method known as depreciation. It is only a portion of the cost called depreciation charge for the year that is taken into expenses for the year. Examples of capital assets are things like buildings, motor vehicles, equipment, and furniture.
Recurrent expenditure, on the other hand, is for consumable goods and services that will be used in operations in one operating year and include variable and fixed costs. Variable costs are costs that vary with production activities such as costs of production, cost of goods sold or any costs that vary with units produced and sold but cannot be directly associated with any unit. If such a cost can be associated with any unit, it is treated as part of the costs of goods sold. Fixed or administrative expenses are costs like rent and salaries, which are incurred whether or not there is any activity. Other recurrent costs that may be variable or fixed depending on the nature of the business are stationery, utilities, insurances, operations and maintenance, transport, marketing, advertising, selling, distribution, delivery, interest on loans, depreciation, etc.
When preparing a budget for more than one month, income and expenses should be placed in the months they are expected to occur. Where revenue and expenses occur, depends on the plans that have been put in place and seasonality of the business. Events that give rise to revenue and expenses vary from month to month depending on factors like seasons, for example, winter and summer or festive and non-festive seasons. Therefore, the monthly budget amounts should not be a mere division of the year’s vote budget by 12 but rather, be based on expected or forecast occurrences of revenue and expenses. A proforma statement of financial position (balance sheet) may be prepared but this is usually not as critical as income and expenditure projections.
The budget should be presented in the form of a detailed statement of financial position featuring all revenues and expenses. The difference between the forecasted income and expenses is forecasted profit/surplus if positive or loss/deficit for the year of budget if negative. The aim should be to have income being more than expenses so that there can be a profit but the normal experience for a business is to have a break-even position for the first two to three years and a profit thereafter. A revenue budget is only a forecast and as such spending should only commence once cash revenue has begun flowing.
A complete budget should have precise and concise notes explaining the nature and purpose of the amount in each budget line. These notes will later help in explaining variations between the actual performance of each expenditure line and its budgeted amount. The budget must be finalized at least a month before the start of a new year. Finally, is to note that a budget is not cast in stone and it should be reviewed at least once in the year to ensure that all assumptions are still relevant.
Estimating Starting Up Costs
Starting up capital is the one-off seed money needed to start the business. Typically, start-up capital includes money for such things as company formation expenses, plant and equipment if applicable, office or premise setting up, furniture, fittings, office equipment, initial stationery and other one-off expenses that are necessary to be paid up before business can commence.
Included in starting up costs are recurrent expenses for the period that you think will take the business to break even, which is usually at least six months and more. During this period, you will partly be financing the business using savings or borrowing.
Estimating Recurrent Costs
Recurrent expenses which are costs that are incurred regularly as the business operates such as rent and salaries. Recurrent costs fall into the following sub-categories:
- Variable costs are costs that vary depending on how many units are produced and sold. Included in this category are the cost of goods produced (sold), selling and delivery costs, and any other cost that vary with output but cannot be associated directly with any unit of output.
- Fixed costs are costs such as rent and administration expenses that do not change whether anything is produced and sold or not.
When preparing a recurrent budget for more than one month, income and expenses should be placed in the months they are expected to occur. Where revenue and expenses occur, depends on the plans that are in place and the varying conditions and seasons that the business undergoes. The information in the business plan is used to prepare the budget. Previous year’s numbers and reasonable assumptions based on prevailing market conditions are also used. The main elements of a budget namely revenue and expenses can be adjusted in an iterative budgeting (prioritization and allocating) process until a desired but realistic and attainable profit position that can be adopted is established.
Contents of a Budget
Below are examples of one-off and a monthly budget:
Table 1: One-off outlays (US$)
|Formation: For registration, or partnership deed or incorporation||250|
|Consultancy: Any third party services such as accounting or legal||200|
|Rent Deposit: First-month rent and 3 months deposit||1,000|
|Redesign, refurbishing, restructuring and decoration of premises||2,500|
|Licenses and permits||100|
|Stationery: Letterheads, logos, business cards and office stationery||500|
|Utilities: Internet, electricity and water connection deposit fees||100|
|Initial marketing and sales material||100|
|Website development costs||500|
Table 2: Monthly revenue and expenditure statement (Budget)
|Cost of Goods Sold||26,112||27,250||28,030||30,650||31,295||32,215||32,265||32,265||32,465||32,465||31,173||33,815||370,000|
|Non-operating Income|| |
|Profit Before Tax||7,261||27,223||27,683||24,783||32,158||30,772||25,302||36,166||32,749||23,806||33,754||27,647||329,304|
|Provision for Tax||2,178||8,167||8,305||7,435||9,647||9,232||7,591||10,850||9,825||7,142||10,126||8,294||98,791|
FINANCING THE BUSINESS
Once you have thought about the business idea, formed your business, and have carried out strategic planning to figure out your strategies for marketing, sales, distribution, customer services, operating facilities, financial management, and administration, it is time to think about the money for starting and running the business until it is self-sustaining. To think through this, you need to estimate starting up costs and consider the various sources of raising capital.
Find the necessary funds to start
Once you know how much you need to start, you have to figure out where the seed funds will come from. Sources of raising funds include personal funds, personal credit, family funds, friends funds (personal loans), unsecured and secured bank and credit union loans, bonds, debentures, peer-2-peer loans, crowd-funding, government loans and grants, discounting and factoring of invoices (receivables), lease and hire, angel investors, venture capital investors, and selling part of equity (shares in the business). Online intra-day and payday micro-credits are also becoming commonplace. Online credit is a loan that you can access from a lender such as a bank through a digital mobile device like a cell phone. Such loans are useful for working capital.
Each source of funds has varying costs and advantages and disadvantages which need weighing. The need for funds and the source should depend on the purpose, the amount needed, legal form of the business and risks around the borrowing. A fixed asset like machinery may take a while to generate income so it is prudent to match this income with related loan repayments. If only US$1,000 is required, the business should not incur the time and expenses of selling shares, for example. Sole-traders and partnerships have limited choices because they cannot easily sell shares or issue debentures. Limited liability companies can not only easily sell shares and issue bonds but they can also borrow cheaply from banks. If there is more debt in the business than owner’s equity (high gearing or leverage), interest rate payments can put pressure on the viability of the business and make it susceptible to takeover by lenders or winding up by creditors.
Using a business plan to solicit funding
**You use a business plan to solicit funds. Any lender will want to know what your business is all about and how it will make money to be able to repay the loan. To be able to answer these questions, your business plan should contain the following:
- Executive summary: This is a one or three-page highlights of the business particularly why the business deserves funding and what is in it for the lender.
- Mission and vision: Mission is a few words or a paragraph that states the main purpose, aims or mandate of the business. Vision is also a few words of what the business aspires to be in terms of progress and excellence.
- Description of products and services.
- Description of the competition and your competitive advantage over the competition.
- Short and long-term goals and challenges if any.
- Marketing, selling, distribution and customer service plans.
- Forecast financials that include an income statement, balance sheet, cash flow and budget (both starting up and operating costs) covering two to five years. This budget and cash flow should demonstrate the need for financing and the ability to repay what is borrowed.
- Administrative structures, ownership profile, employee team and their qualifications, and service providers and supplier team.