Budgeting---quick and easy or detailed and effective?

The traditional budget process takes the existing budget and increases or decreases it by a certain percentage.  This is done as a whole for a really quick and easy method or line-by-line in a more detailed approach.  Either approach gets the job done quickly but are the results worth it?

There are several more modern ways to create a budget for a business: Zero-based, Activity based and Kaizen are among the most popular.  Zero-based budgeting reverses the process of traditional budgeting by starting each line item at zero. No reference is made to the current budget or prior spending levels, instead each expense budget must be justified.

Activity based budgeting groups the business expenditures by activities in the various functional areas such as administrative, sales and manufacturing.  Activities are tied to the strategic goals the company has set and the costs needed to fund the activities are the basis of the budget.  This technique allows a business to align its costs with its goals and objectives, reduce costs and improve business practices.

Kaizen is the Japanese word for continuous improvement and goes along with the lean process.  The budget is set based on future improvements in all areas which means the budget cannot be achieved unless the improvements are made.  This process forces a business to actually implement the changes it has developed during a strategic planning session or goal setting exercise.  The approach has a company work to minimize costs at all stages of the product life cycle and in all areas of the business.

All three of these techniques are much more time consuming than the traditional process but all three give more realistic and thoughtful numbers to work with.  The whole reason to budget is to help guide and manage a business better so even if the process is tedious, utilizing any of these techniques will help you grow your company and achieve greater results.

Preventing Theft and Fraud

I was just reading an article about a local company who suffered a large loss due to employee theft which rallied the old internal auditor in me.  Many small business owners think they don't need internal controls because they know all their employees and none of them would steal from them.  While having a good relationship with your employees reduces the chance of theft or fraud, it doesn't eliminate it.  The Association of Certified Fraud Examiners reported that in 2010, small businesses suffered losses of 5-7% of total revenue due to employee theft. 

Theft from employees centers on what ACFE calls the fraud triangle: Motivation, Opportunity and Rationalization.  As stated earlier, employees who have a good relationship with the owner/manager and who feel they receive adequate compensation are less likely to rationalize stealing from their employer.  A good reason to have happy employees!  Motivation can be due to excessive medical bills, a gambling problem, an addiction problem or other financial difficulties.  Watching employees for signs of increased stress such as an increase in the number of personal calls received, changes in personal hygeine, changes in working hours (coming in early or staying late) or signs they are living above their financial means.

The last way to protect against employee theft is to limit opportunities.  This is done by creating good internal controls.  Even small businesses can set up internal controls as follows:
1. Having the owner demonstrate an active interest in the books and financial reports
2. Provide oversight and review of employees work
3. Segregating duties wherever possible

Duties to segregate include:
1. Separating the opening of mail (and logging payments received) from posting the payments to your accounting system and depositing them in the bank
2. Separating mailing checks with payments to vendors from recording the checks in the accounting system-even better is to use online bill paying where the bookkeeper can enter the payments into the system but only the owner can authorize the release of payment
3. Separating the entry of data into the accounting program from reconciling the accounts-the owner or an outside accountant should be reconciling checking accounts and credit cards

Other internal controls measures include:
1. Reviewing payrolls for reasonableness (is someone padding their hours?)
2. Requiring proper documentation for all purchases (invoices, receipts)
3. Having the owner sign all checks and maintaining control over all blank checks
4. Maintain a list of all fixed assets and doing a physical check periodically
5. Performing a physical count of inventory regularly
6. Requiring management approval for all credit memos or adjustments to accounts receivable
7. Reviewing the books for duplicate payments to vendors or increases in expenses which are unexpected

The ACFE estimates the median loss to businesses in 2010 from employee theft was $128,000 which can cripple some small businesses.  Owners need to remind themselves that while they can delegate tasks to employees, they should not delegate their responsibility to supervise the activities.  Reviewing the books can save your company so look at the financial statements regularly. 

SWOT analysis

Continuing with our year end planning, we are going to talk about SWOT analysis.  SWOT stands for Strengths, Weaknesses, Opportunities and Threats.  We like to use SWOT when starting a business plan as well as a year end planning tool.  It gives the business owner the chance to determine if a start-up has the right mix of strengths and opportunities to offset the weaknesses and threats.  As a year end planning tool, a SWOT analysis gives the owner the chance to look at the business with fresh eyes.

Strengths and Weaknesses refer to internal environmental factors a business faces.  What is the business good at and where are they lacking skills, facilities?  Strengths are the resources and capabilities that the business has to use to create a competitive advantage.  What can your business do better than your competition?  This can include patents, a well known brand name, a good reputation for quality and service, cost advantages from size or proprietary knowledge.

Weaknesses are things which leave a business at a competitive disadvantage such as a high cost structure, lack of access to good distribution channels, lack of a strong brand name, etc.

Opportunities and Threats are external environmental factors a business faces in their quest to succeed.  Opportunities can include unfulfilled customer needs: what do customers want that no one else is selling or manufacturing?  Creation of new technologies or loosening of regulations can also create opportunities for a business.  Failure of a competitor is another way a business can find an opportunity. 

Threats can come from a shift in customer tastes away from your products or services or the emergence of substitute products.  A business must always be looking to create the next big product because eventually someone else will make a product to compete with yours.

A good SWOT analysis involves laying out all the strengths, weaknesses, opportunities and threats a business faces.  How to best organize this information?  A TOWS matrix, which we will cover next week.

Strategic planning

We are back to discussing sales or more specifically, your market.  A key part of any business plan is the marketing section.  The plan lays out the exact market your business operates in both functionally and geographically.  Your target market is defined and a good marketing section will have detailed planning for how to reach that target market.  Also defined is your competition and how your business compares listing both strengths and weaknesses.  We like to do a SWOT analysis with a TOWS matrix whenever possible when creating a business plan to help us define the businesses strengths and weaknesses as well as the competitions.  If you aren't sure what a SWOT analysis is with a TOWS matrix, check us out next week!

While most small businesses define their target market and examine their competition at start-up, not all continue the process.  We think it is very important for you to take a fresh look at who your target market really is each year as opposed to who you thought they would be. Sometimes the target market shifts and sometimes your assumptions as to who they will be turn out to be wrong. Knowing who is buying your products now is very important when determing how to reach new customers. It is also important to look at your competition on a regular basis and see what changes have occurred with them.

Major corporations devote a significant amount of time and money each year in strategic planning and small businesses should commit some time and money to this endeavor as well.  Understanding who you are selling to and who else is offering the same products and services is very helpful when planning your marketing and your operations.

Budgeting process: expenses

The last two weeks, we talked about how to properly create a sales forecast for 2012 which will be used to set goals and also in your budget.  This week we will tackle the expenses.  Many people approach the expense portion of a budget with a broad hand: they increase costs across the board by a set percentage.  The better approach in to go line by line and gather your information.  Talk to your landlord, your utility provider, your insurance agent and find out what they anticipate 2012 to look like. You will also want to consider your staffing levels. If your forecast shows increased sales, will you need more employees? All of this takes time, but you will have much more meaningful numbers to work with.

The whole point of creating a budget is to guide your decision making during the year.  Can you afford to take advantage of a volume purchase discount?  Can you afford to hire more employees?   Is this the right time to expand or do you need to start accumulating cash in anticipation of an economic slump?  Putting together a budget is a little tedious, but the information you get from the exercise is well worth it.