Unlock the power

The lazy man’s budget is ‘last year plus’ and it’s pretty useless. Here’s how to do it right.

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There was some shuffling and head-turning and a few hands went up. I was speaking at a farmer’s day and had just asked how many members of my audience prepared a budget for their enterprises. “OK, guys,” I said, “let me put the question another way. Are you involved in an annual exercise where you have a stab at guessing what every single item of income and expenditure for the business, or your section of it, will be during the next 12 months?”

I was hoping to see more hands in the air, but my embellishment did little good. Even fewer went up this time. It’s difficult to believe, but it’s a fact – many farmers don’t budget. Most probably put pen to paper to make sure they’ll have enough cash to send the kids to school, but that’s not a budget.

Here’s what I mean by a ‘budget’…Your financial year is January to December. At least two months before year end, you need to start thinking about the year ahead. But before you put a single number on paper, you have to identify the key economic assumptions on which you’ll base the budget.

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These include:

  • Inflation rates in all your markets. Talk to a few experts, read the forecasts every reputable economist makes at this time of the year and choose one that seems reasonable.
  • Bank interest rates.
  • Likely exchange rates in all your markets – a very tough call in SA with is yo-yo rates. But always – always! – take a conservative view.
  • Once you’ve given these and, perhaps, a few other items careful thought, it’s down to the nitty-gritty.

What production can you reasonably expect, based on normal weather conditions, hectares planted, stocking rates, yield, calving percentages and the like? This shouldn’t be too difficult to estimate, but then it’s on to the toughest one of all in agriculture – expected product selling prices.

You need to estimate these item by item, grade by grade. Unless you have a well established niche market, this figure is usually completely beyond your control. If you’re an exporter, exchange rates make it doubly difficult. But you have to make a choice.

I always compile three estimates – a low one, a high one and one in-between – and only make a final selection once the full budget is completed and I have a clearer picture of the likely future.

This is familiar territory where you’ll have a much better idea of what’s coming, and can also exercise some control. Don’t worry too much about the many small items which only contribute 20% of the total. Concentrate on the ‘big’ five or six items that normally make up 80% of the total. Things such as salaries, animal feed, fertiliser, pesticides, electricity, fuel, vehicle
spares and transport.

Zero base
Now to the most important point of all! A ‘zero base’ budget delivers a hundred times the value of a ‘last year plus X%’ budget. Let me explain with a real-life example. The pack house manager delivers a budgeted labour cost figure of R575 000. He took last year’s cost and added 6%. Rubbish!

A zero base approach calls for a clean sheet of paper and a complete rethink. Here’s how it should be done:

  • Offloading section: How many people required? We used five last year, but with the change we made to the offloading bay we can manage with four. What rate did these people get last year? Add 6% to that figure for four people.
  • Grading section: We used four people on each table last year, but had a few quality problems. Let’s add two more employees. That’s six in all. What were their rates last year? OK – add 6%.

You get the picture. This and only this is a zero base budget!
When you put a budget together like this, it’s a power budget. It forces you to rethink the operation from the roots up and develop an understanding of the numbers that make the business tick. n short, zero base budgeting brings special insights and unlocks creativity in you and your staff you never believed possible.

Contact Peter Hughes at [email protected] Please state ‘Managing for profit’ in the subject line.