Budgeting – Begin with the end in mind

One of my favourite texts is The 7 Habits of Highly Effective People by Stephen Covey. Habit 2 is 'Begin with the end in mind.'

The principles behind habit 2 are that all things are created twice. There is a mental or first creation, and a physical, or second creation to all things. In building a home you prepare plans and blueprints (the first creation). You really think through what you want to achieve, the vision or outcome. Only then do you put bricks to mortar (the second creation).

The annual budget for a business is the first creation. Financial leadership or living and adapting the budget is the second creation.

Too many businesses commence the budget process at the top. They determine their income first and subtract estimated costs to determine their budget profit. Quite often, dissatisfied with the results, business owners alter income and expense values without clear strategies to determine a more appropriate profit result.

Consistent with the above principles, an alternative budget process is to determine the profit we should or need to achieve. This can be calculated by examining industry benchmark data, meeting your family business needs and goals etc. Your business operating costs are then added to the profit to determine your required revenue.

Adopting the 'bottom up' approach will raise some fundamental questions of your business:

• What strategies will I employ to achieve the desired turnover budget?
• Will I need to develop new products, undertake new enterprises, consider pricing opportunities, win new customers or increase sales of products to existing customers?
• Is my cost structure including personnel appropriate?
• Can I simplify or make more effective my business processes?
• Are my suppliers providing me with the right products to meet my target markets’ requirements?

Too often, the budget process is undertaken to satisfy a bank or because “we should have one." The budget process should be the most important financial management function for business. When employed properly, the budget process should challenge business owners, promote the development and implementation of business strategies and support the goals and objectives of the business owners.

Peter Debus is a director of PrincipleFocus, a Chartered Accountant and Chartered Tax Adviser.?