Preface: Budgeting is the most often utilized tool for cost controls. Budgetary controls encourage financial discipline and that discipline promotes a strong financial statement. Creating a budget, (say incremental, or zero based) and controlling a budget can be tedious or easy given your accounting software features and familiarity with financial modeling. Value costs; every dollar of revenue your business earns is a cost to someone else.
Budgeting and Cost Management
A budget is a financial statement forecast of expenditures or income for a set period of time that has been apportioned to specific accounts. A budget provides key metrics to achieve a strategic plan. It helps coordinate i) the activities of managers ii) furthers your toolbox of financial responsibility iii) communicates important financial information iv) motivates employees by setting clear goals v) promotes managers to think about and plan for the future vi) confers criteria for managers to measure performance vii) promotes income and expense monitoring.
Having the appropriate tools incorporated in your business for financial management is imperative. Budgets are one of those tools you should incorporate. When beginning to plan your budget, keep in mind the value of reliable financial information and the importance of financial controls.
Incremental Budgeting
There are two main methods of budgeting. Incremental budgeting and zero-based budgeting. The incremental method bases this year’s budget on last year’s income and expense account balances with a ratio of arbitrary or calculated increases and/or decreases in individual accounts. If you use the incremental method, which is easier than zero-based budgeting, examine carefully your prior year accounts for variances and be realistic, because budgeting is forecasting your future revenues and expenses. While fixed expenses are easy to budget; revenues are more complex and should include an average of prior years to be more realistic. When drawing your budget, assess factors such as inflation, interest rates, and industry forecasts.
Zero-Based Budgeting
Zero-based budgeting is a method that estimates anew each year the cost and revenue picture. This method requires careful thought and redefining of your objectives.
When you budget with incremental or zero-based methods, keep detailed notes of your rationale for forecasted figures. It may seem obvious when preparing the budget, but notes will help you assess budget vs. actual performance logic and remember the detail of linear webs on reviews.
Most importantly, be realistic. Does your budget seem feasible? Is it achievable? Is it over-optimistic? Have you appropriately computed both variable and fixed costs? Have you gathered complete information about your projected financial performance? Invest the time to budget with realistic forecasts and gather input from those who will need to comply with your parameters. Do they think your estimates are realistic?
Revenue forecasts are foremost. Strive to budget on a level of sales that is attainable and has a high probability of being achieved. If you are realistic, additional sales should only increase your net income.
Track Your Budget
Once you have your budget forecast prepared; review it monthly. Are you achieving your forecast? What do you need to adjust to meet budget? Do you have unanticipated expenses or revenue? Often budget vs. actual differs, but budgetary controls in your financial toolbox will further your business’s financial stability and continuity.
Cost Management
Value costs; because every dollar of revenue your business earns is someone’s cost.
Dollar costs are the value assigned to acquire or achieve something else with money.
Your business profitability is subject to a cost being incurred on behalf of your customers and clients and their wallet shares.
Costs can be fixed, variable or semi-variable. A fixed cost remains level no matter what your volume of business e.g. real estate taxes. A variable cost fluctuates according to sales volume e.g. purchases or raw materials; and then the semi-variable costs e.g. pensions.
Budgeting is the most often utilized tool for cost controls. Budgetary controls encourage financial discipline and that discipline promotes a strong financial statement. Creating a budget and controlling a budget can be tedious or easy given your accounting software and familiarity with financial modeling. What is important is that your business has controls in place to manage costs, not primarily reduce costs.
Cost reduction is different than cost management. The lower your income statement costs, the higher your net income, but lower costs should be accomplished with cost management and not arbitrary cost reductions. While arbitrary cost reductions should be averted, cost management should be promoted. Arbitrary cost reductions are the result of adverse budgeting forecasts, often implemented in financial avalanches. Review and monitor your budget and manage costs to avoid drifts or such financial events.
Effective Cost Management
Effective cost management can help you increase net income even with level to sloping reductions in sales volume. Accurate and timely financial reporting with appropriate accounting software will further your capacity to expertly manage costs and cash flow in your business. Additionally, proper software promotes your financial modeling capacity for capital investments.
Seasonal Fluctuations
Most often variable costs are hinged to sales volume. As salaries and wages increase along with utilities and selling expenses, a consistent upward to level trend in sales must result to compensate for the additional variable cost overhead that is difficult to quickly reduce with income volatility unless you have pre-planned for seasonal sales fluctuations.
One prime cost management tool of a successful company is prompt or pre-payment discounts from vendors. If you purchase in quantity you can reduce costs on volume, but it is imperative to balance quantities purchased and not amplify on volume purchase discounts.
Hidden Costs
Do you know what your hidden costs are, e.g. nominal hidden costs include licensing or associations fees; but the expensive hidden costs associated with income evaporation include pilferage, slacking employee’s, raw material inefficiencies, or fraud. Keep your pencil sharp on your business’s financial statements even if you are consistently profitable. These types of hidden costs may cost more than you may think. It is easier to manage costs proactively than retroactively.
Always keep in mind: it never costs too much to keep your trustworthy and faithful customers and clients. The revenue your business has and can derive from them, costs them. Strive to make the benefits you give in exchange exceed that cost.
Summarized:
Watch black cloth costs with an expert eye, and understand what fixed, variable and semi-variable costs incorporate. Talk with your key employees and advisors to discover ways to expertly budget and monitor costs; and then think about how you can best manage those costs in your business.