Every business should prepare an annual budget, but it’s especially important in the capital-intensive manufacturing sector. Comprehensive, realistic budgets allow you to identify potential shortages of cash, production capacity constraints and other threats. They also can help you develop a strategic plan that takes advantage of opportunities to improve performance. Here are four signs that your budget may not be doing its job.
1.It’s based on last year’s results
Too often, companies create a budget by applying an across-the-board percentage increase to the prior year’s actual results. This approach may be oversimplified in today’s ever-changing marketplace.
Historical results are a good starting point. But some costs are fixed, rather than variable based on revenue. And certain assets — such as machines and people — have capacity limitations to consider. Accurate forecasts of revenue and expenses are prepared on a department-by-department basis and use technology to capture “real-time” sales data.
2. It lacks companywide input
Your finance or accounting department shouldn’t complete the budget alone. Rather, you should seek input from people in every department and at various levels of management.
For example, your sales department may be in the best position to estimate future revenue. The production manager may offer insight into anticipated maintenance expenses or necessary investments in equipment upgrades. And the product development team can help forecast revenue and expenses related to new products and processes.
In addition, soliciting broad participation gives employees a sense of ownership in the budgeting process. In turn, this can help enhance employee engagement and improve your odds of achieving budgeted results.
3. It’s not realistic
Good budgets encourage hard work to grow revenue and cut costs. But the targets should also be attainable, based on industry trends.
Employees will likely become discouraged if they view the budget as unachievable or out of touch with what’s happening in the market. After years of failed attempts to meet the budget, workers may start to ignore it altogether. Tying annual bonuses to the achievement of specific targets can help encourage employees to buy in to the budget.
4. It ignores cash flows
Cash is king. Even if expected revenue is forecast to cover expenses for the year, production and cost fluctuations, as well as slow-paying customers and uncollectible accounts, can lead to temporary cash shortages.
An unexpected shortfall can seriously derail your budget. So, look beyond the income statement and balance sheet. You’ll need to forecast cash flows on a weekly or monthly basis. Then create a plan for managing any anticipated shortfalls.
For example, owners may need to contribute extra capital, or you might need to apply for a line of credit at the bank. Alternatively, you might consider buying materials on consignment, revising payment terms with customers or delaying payments to suppliers to manage the cash flow cycle more effectively.
Recognize the power of fluidity
Markets are constantly evolving, so budgeting is an ongoing process. Work with your CPA to help develop a reliable budget and monitor budget vs. actual results on a real-time basis. The sooner you identify problems, the less likely you are to be blindsided by threats or miss opportunities to grow and improve performance. Continual monitoring allows you to take corrective actions and build a better budget for the future.
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