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SMEs - Please prepare an Annual Budget!

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Every business entity irrespective of its size has to set some goals and targets for the year. That would be starting point of an exercise. This is extremely critical else old management adage would come into play – “You manage what you measure and have no intention to manage what you do not measure”!

One of the best methods to start the process is through the medium of well structured budget.  To start with a budgeting process it would be good idea to determine as what the “limiting factor” would be. The limiting factor would basically be constraints that the organization would have to address in the business process. It would also imply that it would take more than year to address.  The limiting factor could be size of the market, production capacity, regulatory approvals or the like.

The preparation of the budget would also require a bit of analysis of what the cost patterns of the organizations in terms of variable and fixed costs. We recommend budgets are prepared on “Zero Costs” basis.  This assumes that every line of expenditure would have to be fully justified as that would give a great opportunity to analyze all costs. Every function of the organization is to be analyzed for its needs and costs. Before estimating/ making assumption for an expense, a question has to be answered “what is the value that it adds to the business”. Some organizations have the tendency to make a provision of 10% additional based on previous year figures!  It is akin to conceding that if there was 25% inefficiency in the system the previous year to will add another 10% to it this year!!

We would strongly recommend that the budgets are to be prepared for a minimum duration of month and definitely not beyond a quarter.  A typical SME would require the following budgets to start with:

  1. Sales budget
  2. Production budget
  3. Manpower budget – both in terms of number and their costs
  4. Variable costs budget – Function of sales and production budget
  5. Selling & Distribution budget – This would mix of fixed and variable expenses
  6. Expenditure budget – mostly fixed expenditure
  7. Capital expenditure budget
  8. Cash flow budget
  9. Profitability budget

The cash flow budgets will help the organizations to determine their funding gaps and can take timely actions to source funds.  Even approaching the banks would mean that it could take up to 90 days to finalize the credit limits.  Another benefit out of the preparation of the detailed budgets will enlighten the organizations to define well defined policies in respect of all key functions starting from marketing, human resources, purchases, finance, capital expenditure etc.

These will go a long way to measure the actual performance at the end of periodical intervals, again not beyond a quarter.

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Tagged in: Budget SME StartUp vCFO

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