Understanding Business Accounting For Dummies, 2nd Edition (73 page)

When sales skimming is being committed, not all of the actual sales revenue for the year is recorded, even though the total cost of all products sold during the year is recorded. Obviously, this distorts the profit and loss account and throws off normal ratios of gross profit and operating profit to sales revenue. If you have the opportunity to buy a business, please be alert to the possibility that some sales skimming may have been done by the present owner. Indeed, we've been involved in situations in which the person selling the business bragged about how much he was skimming off the top.

Chapter 10
:
Business Budgeting

In This Chapter

Discovering the benefits of budgeting

Designing accounting reports for managers

Budgeting in action: developing a profit plan and projecting cash flow from profit

Investing for the long haul

Staying flexible with budgets

A
business can't open its doors each day without having some idea of what to expect. And it can't close its doors at the end of the day not knowing what happened. In the Boy Scouts, the motto is ‘Be Prepared'. Likewise, a business should plan and be prepared for its future, and should control its actual performance to reach its financial goals. The only question is how.

Budgeting
is one answer. Please be careful with this term. Budgeting does
not
refer to putting a financial straitjacket on a business. Instead, business budgeting refers to setting specific goals and having the detailed plans necessary to achieve the goals. Business budgeting is built on realistic forecasts for the coming period, and demands that managers develop a thorough understanding of the profit blueprint of the business as well as the financial effects of the business's profit-making activities. A business budget is an integrated plan of action - not simply a few trend lines on a financial chart. Business managers have two broad options - they can wait for results to be reported to them on a ‘look back' basis, or they can look ahead and plan what profit and cash flow should be, and then compare actual results against the plan. Budgeting is the method used to enact this second option.

The financial statements included in the annual financial report of a business are prepared
after the fact
; that is, the statements are based on actual transactions that have already taken place. Budgeted financial statements, on the other hand, are prepared
before the fact
, and are based on future transactions that you expect to take place based on the business's profit and financial strategy and goals. These forward-looking financial statements are referred to as
pro forma
, which is Latin for ‘provided in advance'.
Note:
Budgeted financial statements are not reported outside the business; they are strictly for internal management use.

You can see a business's budget most easily in its set of
budgeted financial statements
- its budgeted profit and loss account, balance sheet, and cash flow statement. Preparing these three budgeted financial statements requires a lot of time and effort; managers do detailed analysis to determine how to improve the financial performance of the business. The vigilance required in budgeting helps to maintain and improve profit performance and to plan cash flow.

Budgeting is much more than slap-dashing together a few figures. A budget is an integrated financial plan put down on paper, or these days we should say entered in computer spreadsheets. Planning is the key characteristic of budgeting. The budgeted financial statements encapsulate the financial plan of the business for the coming year.