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Monday, August 1, 2011


Creating a Budget as the First Step to Establishing Reality -
Do we have enough money to start the business of our dreams?  As a first step we will have to determine what the costs and expenses of our business might be before we actually start to move ahead with business planning.

Costs and Expenses
There are expenses that you will incur once at the outset of your business and others that will recur from month to month. These are easy for your to discern: you can collaborate market prices for rent of space and other items such as furniture and fixtures, but how do you compute how much you will be able to sell?
Our market research should have revealed to us what our competition is doing in the way of sales and units sold. If we searched enough and made inquiries, that research will also have an indication of what the cost structure of businesses in the same industry are like. You have also computed what your expenses will be in the first month at least! So we have some information with which we can budget with.

Another issue to address is one of feasibility. Are there enough potential customers in your target market to purchase your product to make sales worthwhile? What happens if your target market is not big enough? What happens if your product is not one that people want to buy? If the answer to these two questions is "No", then don't venture out and start this business.

But if you determine that it is worthwhile after doing extensive market research, how do you figure out Sales? How much can you sell? AND I ask you at what price are you going to sell your product? Remember Sales is a function of Price times Units Sold (Sales = Price x Units Sold). If you look at this equation you have two elements with which to play - - Price (how much to charge in view of your given cost structure), and Units Sold (how much can you sell?). You can arrive at your sales goal in dollars if you lower the price and raise the number of units sold. Or, you can arrive at the same sales goal if you raise the price and reduce the number of units sold.

Take a look at the table below which is used to ascertain the price level and number of units to sell.

This table shows three possibilities whereby the entrepreneur is using varying numbers of units and several price points to determine if his cost structure can be covered with sales. In this budget he will use the average column to expand his budget from month to month. This "flexible budgeting" can be used with your prediction of how the economy will be: worst case, better case, best case to arrive at an average case.

Bottom Up Method
You can also determine a budget by using the Bottom Up Method. Here you would determine what profit you want to have, use your cost structure and then work backwards to determine the Net Sales that would give you the profit you desire. Thus, we are working from the bottom up.

Many people who use the Bottom Up Method have realized that to arrive at the profit that they are seeking they need to expand their business or add on extra help in order to achieve the scale that they desire.

Deviation Analysis
The budget that we have created can be used after we have begun operating for a time. We want to know how well we have done in comparison with what we thought we would do at the initiation of our business. We can take the budget that we have created and compare it do what we have actually done. We can then see how we have deviated from the original plan. Perhaps we have done much better than what we originally planned or maybe we have not done what we aimed for. Take a look at the format below to see how you can use the table above for the Deviation Analysis.

The Comments column is used to explain the variance, which is the differential between Actual and Budget, either up or down. We can write the reasons for the variance, like "we had to lower price to attract consumers and thus didn't achieve the sales level" Or, "due to increasing demand, we raised the price to $xx and achieved greater dollar sales". Or, we achieved greater Gross Profits because the costs of our goods went down". These explanations help management understand how to alter their operations going forward. Feedback enables fine tuning of the operations and makes for a more efficient operation. Thus deviation analysis helps management understand the effects of the economy and supply and demand on its operations.

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