BUSINESS & LIFE: Budgeting

On VF Inc.’s “Cutting Edge of Business,” television programme  on January 7, 2014, Richard Stanton, the General Manager of DIGICEL (Dominica) Ltd, gave some tips for the business sector, especially the small business community.  His chief advise was that companies should prepare a budget before the start of their financial year and that one should always prepare a budget better than the previous year.  He said one should never set a budget that reflects the same or worse position than the previous year.   One should prepare a “Stretch Budget,” which should spur one to achieve results, even if circumstances may result in one that achieving the budget. 

Stanton shared some statistics, which revealed that 40% of small businesses do not know where their next customer is coming from, however, if one had a budget, this would not be so.  In preparing the budget, one would have to begin to identify the sources of income, and this identification process would help in identifying where the next customer is coming from. 

A Budget is a plan of expected income and expenditure.  The Budget must be SMART that is it must be specific, measurable, attainable, realistic and time-bound.  In preparing a budget, one can choose different methods. Two of the most popular are incremental budgeting and zero budgeting.  In the incremental budget, one’s estimates are based on the previous year and it is increased or decreased accordingly.  In the zero budgeting, one starts from scratch, paying little reference to last year’s figures.  There are advantages and disadvantages to both types, however, the important point is to prepare a budget for your upcoming year and to monitor your performance against the budget established. 

The advantages of incremental budgeting include:

1.     Simplicity – the estimates are percentage increase or decrease of the previous year’s budget.  It involves little analysis

2.     Funding Stability – incremental budgeting is structured to ensure that projects to be funded over several years are provided for

3.     Operational Stability – incremental budgeting fosters a consistent and stable approach in operating/managing departments, envisaging no major shifts but incremental ones.

The disadvantages of incremental budgeting include:

1.     Incremental in nature – it assumes incremental changes when changes may be more structural in nature and this makes the budget irrelevant

2.     Fosters overspending – you may have heard people say, “if we don’t use it, we will lose it,” and especially towards year-end, they sometimes make purchasing decisions that are not prudent.

3.     Budgetary slack – there is a tendency to deflate revenue and inflate expenses, so that the variances are favourable and it gives the impression that they have done or are doing a great job

4.     Budget Review – it discourages comprehensive review of operations and the previous budget as there is often a tendency to increase or decrease by a set percentage

5.     Poor Resource Allocation – since the budget is based on previous year, sometimes long after a particular activity is useful, funds will be allocated to it or sometimes even if still useful, too much funds may be allocated to a particular activity

6.     Discourages Risk Taking – it fosters a conservative mindset, which discourages risk taking.  This makes it difficult to assign funds, especially significant funds to a new, however critical area (Steven Bragg (2013), What is Incremental Budgeting).

The advantages of Zero Based Budgeting include:

1.     Efficient allocation of resources as allocation is based on needs and benefits and not on previous history

2.     Drives managers to discover cost-effective ways to improve performance

3.     Helps detects inflated budgets and identifies wasteful spending and operations

4.     Increases staff motivation by providing greater initiative and responsibility in decision-making

5.     Improves and increases communication and coordination between departments and the organisation as a whole

6.     Identifies opportunities for outsourcing

The disadvantages include:

1.     More time consuming than the traditional incremental budget

2.     Justification of every line item may be more difficult, especially for departments with intangible outputs

3.     Training required due to increased complexity

4.     Requires involvement of more personnel (Wikepedia)

I personally prefer the zero based budgeting even if it is more time consuming and complex.  I prefer it because it forces you to objectively evaluate performance, to identify specifically the sources of income and the uses of funds, to prepare a comprehensive action plan to achieve the budget, especially in terms of revenue.  This way, it takes care of one of the key problems faced by small businesses:  it forces you to identify the next customer. 

Budgets are not always realized.  Sometimes one exceeds the budget, and other times, one under performs, however, one must always have one.  It serves as a guide, a beacon in the dark and is especially critical in difficult economic times.  In times of fast economic growth, one may do well, even without working towards it, however in times of recession, one has to plan and prepare for success.  As Napoleon once stated, while no plan survives battle, no one goes to war without one, so too, while a business may not realise its budget, no business can function without one. 

I can be contacted at [email protected] and 767 449 9649. 

Until we meet again, May The Lord Continue to Keep Us in the Palm of His Hands.

Blessings & Best Wishes Always