How to do a budget plan from zero without getting on the verge of a nervous breakdown
Pedro Almodovar is a wellknown Spanish director and screenwriter. He achieved international recognition in 1988 for his black comedy-drama film Women on the Verge of a Nervous Breakdown, which was nominated for the Best Foreign Language Film.
We are in July 2022 and we live in a black comedy-drama which involves a pandemic, a war next door, double digit inflation, energy crisis, severe temperatures, famine risks and you can name a few more. There are all possible signs to be on the verge of a nervous breakdown and this time it would not only affect women.
I have been recently involved in a media project pitch and got the feedback that the idea was interesting, but the execution was just talk. At first, I was surprised: come on, I was not that type of professional entangled in abstract, empty words strategies. I am self aware (as many trainings have taught me) that I am a sharp, practical and precise preach.
Whatever I thought, they were right. We have slightly become talkers, focusing on things we believe would make a difference. The high energy prices from the winter to come would not be accommodated in our personal or business budgets by a better positioning, content creation or avatars. We would be able to do that by rethinking the way we are budgeting for the next year.
A budget is one of the short-term tools that is used to work towards achieving long-term objectives. Whenever there is a period of instability, it is recommended to be rather pessimistic than realistic when you establish your long-term objectives and, consequently, budget them on a yearly, quarterly and monthly basis.
It is important to distinguish between a budget and a forecast. Forecasts predict what might happen in the future, budgets set targets for the future.
There are two ways of budgeting:
- incremental budgeting (the previous year’s budget or actual results are used as a starting point for increasing/decreasing)
- zero-based budgeting (all activities within the business start with a budget of zero and you must justify why money should be allocated to every activity)
Considering the current situation - on the verge of a nervous breakdown - I would recommend a zero-based budgeting as more challenging for the status quo, more accurate and more suitable to bring true innovation.
How would you do it?
1. Sales Budget comes the first and it shows the total sales expected to be achieved during the budget period. Split them per quarter, ideally per month.
- Sales = Budgeted sales units X Selling price/unit
- When you have a diverse portfolio, you should set your sales units and selling price/unit expectations per each SKU (Stock Keeping Unit).
2. Production & Production related Budget comes the second (if you have production within your business) and it is based on the sales budgeted data.
2.a. Production Budget:
- Budgeted sales units + Budgeted closing inventory * = Units needed
- Units needed - Opening inventory**= Budgeted production units
* Budgeted closing inventory is an amount that should still be in stock at the end of the budget period, which can then be carried over to the next budgeted period. This is done to prevent the business from running out of stock.
** Opening inventory is the inventory you have at the beginning of the budgeted period, this is why you deduct it from the budgeted production units
When you produce something you need:
- 2a.1. Direct labour (only workforce that is DIRECTLY involved in the production of what you sell as a business)
- Budgeted production units * Direct labour hours per unit produced = Budgeted direct labour hours
- Budgeted direct labour hours * Cost per direct labour hour = Budgeted direct labour cost
If you have different types of labour and associated costs, then you must split them accordingly and the budgeted direct labour cost should be a total sum of the sub-sums.
- 2a.2. Direct material (amount of direct material that goes into each unit produced, and the cost per unit of direct materials)
- Budgeted production units * Units of direct material required/ unit produced = Direct material needed
- Direct material needed + Budgeted ending direct material* - Beginning direct material **= Units of direct material to be purchased
- Units of direct material to be purchased * Cost/unit = Budgeted direct material cost
* Budgeted ending direct material follows the same rule as for inventory - you need to have a safety stock of material that would be carried over tot the next budgeted period
** Beginning direct material stock is what you have when you start the new production and must be deducted from the total direct material needs
2.b. Production Related Budget:
Besides direct labour and direct material, there are some other production related costs, which can be split into:
- variable - they go up/down based on the production quantity (eg: the electricty needed to run the production equipment)
- fixed - rent that you pay for the production site and/or places where you sell your products, production workers salaries, transportation cost
3. SGA (Selling, General and Administrative) Budget
This is the budget with all expenses that do not relate to manufacturing and are also split into:
- variable - eg commission sales or transportation for deliveries to customers, marketing expenses, etc
- fixed - workers salaries (others than those who are involved in production), office rent, bank interest, etc
Each function/department should be included in this budget with its own expenses, split into variable and fixed.
For a small sized company the most common functions would be Marketing and Sales Promotion, Administrative/Office.
The Administrative/Office sub-budget would consist of all expenses related to office rent & other expenses, collaborators (eg external accounting and legal), IT related subscriptions, bank related costs (interest, commisions, etc).
In many companies there is a tendency to put marketing as the queen of all expenses (believe me, I am a marketer:), but a fair balance should be taken into account particularly in times of potential nervous breakdowns like these ones we are living in.
When you have your Sales, Production and SG&A budgtes ready, you can prepare the Cash Budget because the actual money you would have at your disposal is more important than any money on paper/excel.
Now, imagine that your sales budget is 100. How much would you actually invest in:
- Production & Production related budget? 20,30, 50?
- SG&A budget? How much of the remaining 80,70,50 would be split into: marketing, sales promotion, administrative?
- How much of what you have in marketing would be actually split into: brand marketing, digital marketing, inlfuencer marketing, bla bla marketing?
Photo credit: Cristian Șuțu
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