Is Budgeting a Waste of Time for Small and Medium Enterprises (SME)?
There is a famous quote from TshOxenreider “The simplest definition of a budget is “telling your money where to go.”
It is crucial for SMEs to estimate their income and expenses, and based on this estimation, tell their money where to go.
Budgeting ensures planning and monitoring of financial activities; therefore, it is essential for SMEs who would like to sustain and grow their operations.
What is a Budget:
An estimate of income and expenses for a set period is known as a budget.
Are There Different Types of Budgets:
Yes, there are various types of budgets, depending upon where it is required. These include but not limited to historical or incremental budget, flexible budget, zero-based budget, Kaizen budget, etc.
It is a fact that due to constraints of finance and lack of staff and controls, SME may consider Historical or incremental budget as a management and control tool for their organization.
Approaches to Budgeting:
There are mainly two approaches to budgeting. The top-down and second one is bottom-up. To elaborate top-down budgeting, it means the top-level (strategic management) of the business decides the budget for a particular period, and the whole team works to achieve that budget. Another one is bottom-up budgeting which attempts to determine the underlying cost of each segment of the organization and then total up each department. As this is being developed at the operational level, therefore it is less stressful for the operational and tactical management, and this has more achievability sense and targets as compared to top-down budget.
Factors to consider while developing the budgets:
When we talk about planning and budgeting, there are various factors that we need to look at:
- If a company is new, then we may have to a look at the financial data of another comparable company who is of the same size and also operates in the same industry. A new company needs to look at the sales, operating costs, revenue, and salaries of the comparable company to develop a budget. This is a kind of historical budgeting.
- Whereas when an established SME considers developing a budget, then the company has to follow some essential rules otherwise result will be pretty different as per expectations. We see many new SMEs start their business and in short period fails, one of the reasons behind this failure is lack of planning and budgeting.
- A very optimistic and high budget may lead to lack of motivation and stressful due to un-achievability.
Similarly, a pessimistic budget may lead to lack of focus and desired targets.
- Lack of focus on elements of costs. As an example is research and development cost.
Research and development costs include fixed cost and variable cost elements. A startup has to bear these expenses, whether the company is generating revenue or not for a particular period. As the fixed part is unavoidable, therefore a proper budget development activity may devise a plan to minimize the variable elements of costs.
- Another factor that has a significant influence on the company is forecasting a revenue stream, which means that a company must have a goal on which the whole team needs to work together. While developing a budget, a company must use conservative and achievable revenue estimate/targets.
- Emphasis on the non-financial budgeting factors also plays a part in developing a financial target/budget as one may say that a company cannot generate their forecasted revenues without having a strong customer base.
- Discussing expenditure with tactical management (head of the department) will sort out many issues and problems regarding practical budgeting and behavioral issues during the financial / budget period.
- Creating a contingency plan or allocating costs for contingency may help small business to do better in times of recession. Conducting risk analysis and planning for financial under performances helps to develop a contingency plan.
- The most critical thing regarding budgeting is planning a regular budget review. If a budget is reviewed quarterly, it allows flexibility and acting in response to a situation helps a business to grow properly.
Budgets are a useful discipline they help to have a target and to see how realistic your estimates are, plus of course banks and other third parties often ask for them.