Business Budgeting

It is important to understand that there are different kinds of budgets. The various versions of business budgets all reflect business goals and objectives for a specific, future period of time. Budgets and forecasts support and underpin short term business plans. Budgets are not always expressed in monetary terms.

For example, a production budget is usually expressed in volume of output terms (e.g. for a feedlot the budget is expressed in kg of beef live weight, or kg of beef dressed weight).

Some different kinds of budgets are, for example:

• Operating budget
• Revenue budget
• Expense budget and subsets (e.g. labour budget, fixed costs budget, variable costs budget)
• Budgeted Income Statement (also known as a Profit and Loss Forecast)
• Capital budget
• Resource budget
• Development budget
• Cash blow budget

The main benefits of budgeting are:

• In establishing a budget, one is forced to study the related aspect of the business being budgeted for. The cash flow budget, relates to every aspect of the business.This can lead to finding new ways of increasing profit.
• Goals are set for everyone to work towards, knowing that profits will result if the job is performed effectively.
• It enables business managers to delegate responsibility without loss of control. If the results of budget development conform to the management plan, business can concentrate on future developments.
• It encourages the team to think, work collectively and increase joint effectiveness.
•  It clearly defines the individual's responsibility given responsibility for an area covered by the budget.
• Any adverse change in trade conditions can be evaluated and acted upon to minimise effect.
• It enables maximum use to be made of available financial resources.
• Management can examine the effects of policies prior to decision-making.
• Budgeting is the only way of determining when and to what extent additional finance may be necessary.
• Businesses with comprehensive budgets find greater favour with financiers and their Board of Directors.
• Budgets are useful for risk management and testing scenarios

As indicated above, budgets can be used as a motivational and inclusivity tool by management. For management purposes, it is preferable that the budget is established at attainable levels which motivate staff by promoting performance with an emphasis on cost control.

Budgets are prepared for specific lengths of time. In most businesses a budget is prepared for a period of one year, although most large organisations establish budgets for periods of five years.

For a typical cash flow budget, forecasts are usually broken down into monthly figures for a twelve month period, although this may vary, e.g. businesses with quarterly billing cycles. Preparation of the budget before the financial year begins is highly worthwhile even though the actual result of the previous year may not be known in detail at this point in time.

The budgeted Statement of Financial Position is one budget that is for a point in time as it is a forecast of where the Statement of Financial Position (Balance Sheet) is planned to be at the end of the budgeted period.

Financial budgets, projections and forecasts are strong indicators of the potential for success or failure of a business. Components of a business's financial plan typically consist of short range (one year) and long range (three, four and/or five years) planning. Financial expression of business plans are represented in the following:

• 1, 2 and 3 years of cash flow budgets - year 1 broken into months but years 2 and 3 annual
• 1, 2 and 3 years of forecasted Income Statements (profit and loss projections)
• 1, 2 and 3 years of forecasted Statements of Financial Position (balance sheet projections)

Together, the cash flow budget, forecasted income statements and forecasted statements of financial position can be used to generate a reasonable estimate of a business's financial future, but equally important, is the process of thinking through the financial plan to improve the business owner or manager's insight into the financial workings of the business.

Operational business plans are generally created for the next twelve months. Whereas strategic business plans usually cover the next three to five years. Financial components of a business plan are termed budgets, projections or forecasts.

The cash flow budget is the most important budget that a business must create. In order to cover business expenses, it is essential to monitor monetary incomings and plan ahead to meet outgoings.

Without cash flow a business will grind to a halt. Staff and expenses, such as drugs and other overheads, need to be paid. The business owner requires money with which to repay borrowings, cover return on investment and supply a wage equivalent to the business owner. Even not-for-profit enterprises need cash flow and some profit to be sustainable.

The cash flow budget reflects and also permeates every level of business activity, integrating sales plans, expense plans, asset requirements and financing and should always be linked to the strategic, or business, plan.

For a veterinary practice, cash flow budgeting is of particular importance. Veterinary sales income is generally received in small amounts, on a daily, weekly or monthly basis (if accounts are offered).

Outgoings for a veterinary practice are generally in small, medium and large amounts. Receipts and outgoings are not necessarily synchronised and as such there may be a short fall at times. Hence, there is need for anticipation of these times, which is achievable using a cash flow budget.

Also, in times of excess cash in the bank, plans can be made for best use of the money, and at the very minimum some can be put aside to earn a higher interest rate than that offered by the working account for the business. Again, the cash flow budget makes it possible to effectively manage business finances.

The following factors lead to effective budgeting:

• An accurate accounting system (i.e. the financial statements and reports for the business)
• A clearly defined and realistic policy to underpin the budget period (from strategic plan)
• Active participation by leaders (do not delegate to administrative assistants)
• Enabling team members/staff to participate in the budgetary process will promote alignment with the business's goals.
• Determined administrative responsibility for regular preparation and reporting to a person or a department
• A degree of flexibility - plans expressed through budgets are based on the facts available at that time
• Use of realistic figures and achievable targets.

The cash flow budget shows anticipated cash flows, and the aim is to expose times of anticipated mismatch of incoming monies to outgoing monies, i.e. shortages or excesses. Once exposed, steps can be taken to make arrangements for these times. The cash flow budget contains the following main sections:

• Anticipated incoming receipts (monies) from sales or other
• Outgoings of for operational expenses
• Outgoings for investments and financing of the business

The recommended cash flow budget for a veterinary business is the twelve month cash budget, i.e. showing each month's cash position. As this budget can be quite extensive it is useful to prepare separate schedules for incomings and outgoings and then import the respective schedules or their subtotals into the budget.

An example of part of a cash flow budget for a veterinary business is the twelve month cash budget, i.e. the budget shows each month's cash position. As this budget can be quite extensive it is useful to prepare separate schedules for incomings and outgoings and then import the respective schedules or their subtotals into the budget.

An example of part of a cash flow budget for a four month period is shown in Table 1 below:

The above table makes the cash flow budget look simplistic, but in reality there is a lot of data to be incorporated.

Listed below are a number of steps to follow when setting up a monthly cash flow budget for a business such as a veterinary business:

• Gather relevant financial statements, reports and knowledge
• Set up a monthly schedule for expected money inflows
• Set up monthly schedules for expected payments for outgoings - operational, investment and financing

Then set up a spreadsheet such as an excel file with rows for:

• Months of the year e.g. July -> June, and Total Year
• Opening bank balance
• Cash incomings (receipts and asset sales)
• Outgoings - operational (purchases and overhead)
• Outgoings - investment & financing
• Net cash flow (excess or deficiency of available cash over outgoing payments)
• Closing bank balance
  • Create subtotals and totals for each column
  • Create tests to make sure the components in the months add up to the yearly figure i.e. reconciliation
  • Create the budgeted ending cash balance for each month
  • Create the beginning cash balance for the next month

Data for populating the spreadsheet is obtained from historical information and other budgets if they exist, and from information known to management. The Income Statement, either for the full twelve months, or from monthly Income Statements from the year prior, is a good source of information for this schedule.

In practice, cash flow budgets are prepared for the year in advance, on a monthly basis. For a veterinary practice, knowledge of seasonal effects on income and typical patterns of outgoings is helpful.

The relevant information required to create a month by month annual cash flow budget for a veterinary business includes:

• cash receipts from the last 12 months
• aged receivables for monies owed to the veterinary business (e.g. 30, 60, 90 day balances)
• income statements (Profit and Loss)
• knowledge of seasonal effects on income (obtain from monthly income statements)
• knowledge of typical patterns of outgoings - ad hoc, quarterly, monthly, fortnightly, weekly
• principal (capital) and interest payments for loans and the pattern for these
• tax payments - GST, PAYG, (do not include personal tax)
• opening bank balance -from the relevant bank statement or from the Statement of Financial Position (Balance Sheet)

Income for veterinary practice businesses is from two main areas:

• sale of services and animal health items and these are either paid for on the day of sale or sometime in the future (if credit allowed e.g. for long term clients)
• non-operational sales, such as the sale of a motor vehicle.

For a veterinary practice, the bulk of incoming money will be for sale of services and/or animal health items. Receipt of some of this money may not be in the same month that the veterinary work was done. Some of the money will be received by the business at a time later e.g. during the next month. Incoming cash receipts for the typical veterinary business will be for veterinary work done and paid for immediately (cash sales) or within the period, and collections for veterinary work done in a period. This will include value added tax component (e.g. Goods and Services Tax - GST, or VAT if in other countries).

The other incomings section of the cash flow budget is to include anticipated money inflow from non-operational sales. Examples of non-operational sales include sales of investments, plant and equipment and in the case of a company, issue of shares.

It is useful to prepare a schedule for anticipated money inflow to the business separate to construction of the actual cash flow budget. These percentages can be estimated by using the previous twelve months aged receivables reports for the business. As an example, consider a veterinary business such as one of the case study practices, Allansville Veterinary Clinic (AVC). 

For AVC the general payment pattern seems to be that only 60% of clients actually pay at the time of service, while the other 40% have their veterinary work put on account.  Accounts outstanding accounts past the end of the month in which the work has been done (i.e. the first month) are paid  by the end of the second month, while 65% of the outstandings are still unpaid by the end of the second month.

Table 2, below, is an example of an anticipated money inflow schedule for Allansville Veterinary Clinic. The example demonstrates the combined effect of a delay in payments for veterinary services and seasonal variation in sales. The calculations behind the table can also be viewed in the excel spreadsheet for Allansville Veterinary Practices cash flow budget and forecasts.

As discussed above, the major categories of outgoings for a business are operational, investment and financing. The payment of these will not be directly related to when monies come in to the business from sales.

Operational outgoings (expenses) are incurred by veterinary businesses just like any other business, and these include, for example, wages, purchases and electricity. Payments for operational outgoings are not necessarily evenly distributed over the year, with different expenses needing payment predictably on either a weekly, monthly, quarterly or annually basis and some on an ad hoc basis. Seasonality of business activity and/or other patterns may affect payment amounts over the year. It is wise to create a schedule in which to work out the detail, then transfer the totals for each month to the cash flow budget itself. This schedule will be multiple rows in a spreadsheet and include such operational expenses such as purchases, wages, GST. It does not include depreciation.

Examples of operational outgoings schedule and their payment frequency are shown in Tables 3 and 4 below:

Investment outgoings are payments for purchased inventory, plant and/or equipment or other assets. For the purposes of a veterinary practice cash flow budget, in which cost of goods sold includes the cost of external services used on behalf of clients, and that inventory is a current asset, inventory cost is incorporated into the operational expense schedule. For more information please read the Learning Guide, Pricing of Animal Health Items.

Examples of outflows of cash for the investment section of the cash flow budget include $10,000 for a major piece of plant or a $3,000 monthly capital payment of a loan. Financing outgoings include expected borrowings and the repayment of borrowed funds plus interest, including finance lease capital components. 

Table 5, below, is an example of a schedule for investment and financial outgoings. For the purposes of simplicity these are combined as often capital and interest payments are made in combined monthly loan payments.

The cash flow budget is set up as illustrated in Table 6, below, with columns for months of the year ahead e.g. July ->June, and rows for the following:

• Beginning cash balance (in bank)
• Receipts - cash sales, collectables and any other non-sales related income anticipated (import schedule totals of these for each month)
• Outgoings - operational - import the schedule totals for each month
• Outgoings - investments and financing - showing expected payments for purchased inventory, plant and/or equipment or other assets, expected borrowings and the repayment of borrowed funds plus interest
• Ending cash balance

• Create equations to treat the data in each column of the cash flow budget, such that:
• Outgoings(operational) + outgoings(investments + financing) = total outgoings
• Cash Receipts - total outgoings = excess/deficiency
• Download a copy to see how the equations are set up in Allansville Veterinary Clinic's cash flow budget excel spreadsheet.

Create equations for each row to subtotal each line. Create equations to test the reconciliation of the row totals and the column totals. Test out that the same answers can be arrived at two ways.

Beginning cash balance + excess/deficiency = ending cash balance

The closing bank balance for each month becomes the opening bank balance for the next month. Use spreadsheet functions to automate this. See Table 7, below, for an example of three months of a cash flow budget showing the net cash and the closing bank balance at the end of each month. The example also shows how the closing bank balance becomes the opening bank balance for the next month.

In Table 8, below, is a summary of principles, don'ts and cautions for budgeting:

Once set up, the cash flow budget can be, and should be, used in three key areas:

1. From which to create budgeted financial statements (Income Statement and Financial Position Statement) to correspond to the period
2. As the basis upon which to regularly review actuals against objectives
3. As a tool to undertake 'what if' analyses.

1. What next - Budgeted Financial Statements for the next 12 months

Once the cash flow and other sub budgets have been created, a budgeted Income Statement (Profit and Loss) and a budgeted Statement of Financial Position can be created. Once established, these can be used for forecasting purposes, and also against which to evaluate performance.

Data for the budgeted Income Statement is obtained from the cash flow budget with the addition of provision for depreciation. Depreciation does not appear in the cash flow budget as it is not actually real cash that can be put into or taken from a bank account.

The budgeted Statement of Financial Position is a projection of the financial position of the business at the end of a period, and in this case at the end of the 12 months covered by the cash flow budget and the budgeted Income Statement. Data for the budgeted Statement of Financial Position is derived from:

• the actual Statement of Financial Position at the end of the preceding year (i.e. the day before the budget period starts for example 30th June 2014, for 1st July 2014
• budgeted figures for the coming year for items (e.g. property, plant and/or equipment acquisition, loan pay down, drawings by partners, share dividends, share capital raising)

2. Regularly review actuals to budgeted objectives

Budgeting is a management tool, and management accounting is flexible and used by those working in and on the business on a daily basis, rather than by the taxation accountant. If using a business computer program, budget reports can be produced at whatever interval or frequency suits the need. For example, the cash flow actuals against budget can be produced weekly if a business has concerns about having sufficient cash to pay wages and bills.

Comparison of actuals to budgeted figures as the year progresses enables revision of business operations to constantly align, or even better, outperform the budget. Once a budget is developed, the three R's should be applied:

•     Review - analyse variances between actual and budget on a regular basis
•     React - take corrective action if variance is unfavourable
•     Revise - modify future plans and the budget

3. Undertake ‘what if' analyses - for risk and opportunity management

Anticipation of future events and planning for times of negative and positive balances is critical in business and this is where the cash flow budget is extremely important.

Budgets, and most importantly the cash flow budget, can be used for sensitivity analysis for a variety of hypothetical scenarios. For example, budgets can be adjusted for anticipated worst case and best case scenarios. The implications of different scenarios occurring can then be discussed and forward plans for such scenarios can be made.

An example for a mixed practice is a drought scenario budget that aims to predict the effect of drought on practice income. Another is a budget for an exotic animal disease outbreak. A small animal practice may wish to create a budget in the case of a fire in the building.

As such, budgets can be used to make informed decisions about projects or scenarios, anticipated future problems or business opportunities. This can be a very powerful application and use of budgets.

• Carlon, S., Mladenovic-McAlpine, R., Palm, C., Kimmel, P. D., Keiso, D. E. & Weugandt, J. J. 2012. Chapter 17 Budgeting. Accounting Building Business Skills 4th Edition. Fourth ed. Australia Wiley.
• Lindsay, Noel. Director Entrepreneurship, Commercialisation and Innovation Centre, University of Adelaide, South Australia.