Step 4. Sales forecast. The sales forecast should precede the cost and expense budget. Because your business and marketing plan is based on assumptions concerning an expanding market, the sales number should be developed as a first step. In many companies, expenses and sales are budgeting separately, which makes no sense all. Sales forecasts should be broken down by market, by month, and, if necessary, by sales office or other “unit of production” in your marketing arm. This enables you to later identify causes of variances.
Step 5. Budget. The cost and expense budget is based on intelli¬gent assumptions related to the nature of the category. But in addi¬tion, the budgets will be directly affected by sales levels and timing. For example, if you believe that the summer months will experience a much higher than average sales volume, then it makes little sense to spread operating and variable expenses evenly throughout the year. You will then have timing differences in your budget. While these may not be major problems, they do cloud the important issues, often hiding real unfavorable variances from view.
Often overlooked in the budgeting process is the importance of cash-flow projections. Once you have completed a sales forecast and cost and expense budgets, you should next develop the year’s cash-¬flow projection, as part of the test to see whether the plan will work. What could go wrong? Cash flow will be affected by any number of situations. For example, what if you need to invest in capital assets? What if the new sales volume occurs on account, but related costs and expenses must be paid monthly? What if your inventory level has to be doubled in the first quarter? All these events will demand addi¬tional capital. You need to ensure that you know where that capital will come from.
Step 6. Monthly review. This is a process of comparing actual to budgeted outcomes. The review should involve sales forecasts, cost and expense budgets, and cash-flow projections. Without the monthly review, you are not going through the budgeting process at all. Instead, you’re letting the effort go to waste. Only by looking at the numbers can you tell whether the plan is working.
The review can be simplified to a great degree. This is most desirable. You don’t want to keep a room full of busy managers and executives sitting for hours while going through a large volume of detail. All you need is a report showing each category in three columns: actual, budgeted, and the variance. If the variance is minor, no action is required. But if the variance is unacceptable, proceed to the next step.
