A few words about budgeting for 2022

Mission Impossible?

"I feel lost, I have no idea how to go about it" - greeted me Darek, my longtime friend who has been running his company for 15 years.

“A month ago, I started the budgeting process. Twice I thought that I was nearing the end when…new economic data were released and turned my work upside down. If not inflation, then an increase in the minimum wage, then a change in interest rates. New act drafts  are published on a permanent basis, including those related to the announced New Deal. How many changes can they make!!" - Darek continued nervously.

“I don't have the strength to do it anymore, I keep getting lost. Help me! "

It won't be easy ...

That’s when I realized how difficult it can be for people who do not have extensive knowledge in the field of finance, extensive experience in creating forecasts and budgets, to prepare such a budget for 2022. I myself "digest"  every day what impact on my company’s situation will the changes in the law and dynamically changing economic indicators have. I have a lot of questions…

What is certain in recent times of uncertainty is that the last 1.5 years have brought enormous challenges and changes, to which all entrepreneurs had to adapt very quickly. Changing the form of work (remote/hybrid work), numerous absenteeism of employees resulted in a huge demand for employees. Changes in the economy, such as the increase in inflation and numerous changes in the law, have affected us all.

Over the last 1.5 years, a very large increase in inflation has been recorded in Poland. In August 2021, inflation in Poland amounted to 5.4%. This is the highest level in more than 20 years and the rate continues to rise - in September 2021 it was already 5.8%. Unfortunately, we are ranked in the first place along with Lithuania and Estonia by the highest inflation in Europe. In recent days, the Monetary Policy Council raised interest rates, which has already influenced changes in exchange rates and will have an impact on inflation rates.

Increasingly, economists are also warning us of the worst-case stagflation phenomenon in the economy, which consists in the simultaneous occurrence of both significant inflation and economic stagnation in the economy of the state. It is stagflation that is one of the main causes of major economic crisis’s.

The upward trend also applies to employees' salaries. In June 2021, they were 9.8% higher than in the previous year.

It is difficult to find an organization that has not felt the negative effects of the changes that have occurred and are still taking place. Depending on the industry,  for some organizations, the increase in salaries is more noticeable, for others - new public law burdens, and for others - a dynamic increase in energy charges, food prices, and prices for materials and raw materials.

It shouldn’t be forgotten that advanced work on introducing the New Deal is in progress. The tax changes described therein are over 700 pages long. We are still not sure what changes will be introduced and how they will affect our organization, the salaries of our employees, the amount of the employer's overheads and other public liabilities.

According to experts predictions, an ‘avalanche of employees' requests for salary increases will soon start. Inflation is rising and is becoming more and more felt for every citizen. Many of them will also feel negative effects on their household budgets after the introduction of the resulting regulations from the New Deal. All this will result in a decisive and massive increase in financial expectations among employees.

The worst-case scenario for any owner and management board that can happen is to be unpleasantly surprised at the end of the year when they find themselves in a crisis situation and are on the verge of losing liquidity.

Or maybe the other way? Is the current economic situation for some industries (e.g. recruitment companies), conducive to the company's development? The process of building a budget usually prompts owners, boards and managers to think strategically.

For all of the above reasons, it is worth devoting more time to the budgeting process for 2022 to prevent this from happening and prevent that we do not take action on time to prevent our own business from taking a step back or having to consider the legitimacy of continuing the operation in 2023. Or that we did not take advantage of the opportunities brought by economic changes, thus lagging behind our competitors.

How not to wake up with disappointment?

Aristotle's words fit perfectly here - "True knowledge is the knowledge of causes."

It is worth spending more time to ensure that our budget for 2022 provides for as many possible scenarios as possible, what may happen in 2022 and the following years, and which may have a significant impact on the situation of our company.

Below are some tips on how to budget in 2022.

Step 1 - Analysis of the key factors influencing the activity, i.e. what can significantly change the situation of our organization.

Which items in the profit and loss account and balance sheet should be paid particular attention to, when budgeting for 2022? Maybe it is also worth preparing a flow forecast? And so:

1. Revenue. Revenue drivers will vary greatly depending on the specifics of the industry. In the analysis, pay attention to the market situation of customers, because it will also affect your ability to generate revenues.

2. Costs. Start by observing how they changed in 2020 and 2021. The so far considered fixed costs will remain unchanged, will the current inflation lead to their further increases in periods shorter than one year? The market is a system of related vessels, so seemingly unrelated areas may affect other costs.

• Wage costs will significantly affect the prices of goods and services, where there is still a low degree of automation and high personal involvement.
• Energy costs will drive up the prices of products that are expensive to produce.
• The costs of raw materials, , unfortunately, will not decrease. Will they be available on time? Do we need to increase our inventory to maintain the continuity of production and deliveries to the customer?
• The cost of gasoline is an automatic increase in the cost of transportation services. You may find it more beneficial to buy goods and services from local suppliers.

3. Will the financial costs of factoring increase? What is the current loan agreement, will there be additional fees? Have the legal changes led to the creation of new public-law obligations, fees that will be required from January 1?

4. In which areas are transactions in foreign currencies? Changes in exchange rates will affect all items in the profit and loss account, where the settlement takes place in an entity other than PLN.

5. Receivables and liabilities change not only due to exchange rates, but also here there were changes in payment terms, which further translates into the need to plan flows so that there is enough money in the account to pay employees and suppliers.

6. Will stocks freeze our cash or will we sell immediately after the production process is completed? Do we need to plan an additional loan?

7. What investments are necessary to keep the property in good condition? Will the construction / acquisition of new fixed assets increase depreciation costs and affect the selling prices we can offer to clients? Will the customer buy the product / service at the new price?

Investigate what the situation was like in the past. Analyze how it changes. Assign areas that will be affected. Check if the result, balance sheet and flows are consistent and realistic.

Step 2 - scenario analysis

When we manage to identify the main items and determinants that are key to our business, it is worth making a detailed analysis and preparing a scenario analysis including optimistic and pessimistic variants of the development of the situation for given items. The greater the impact of a given item on our operating activities, the more we should follow the precautionary principle and the less optimistic option should be adopted in the budget itself. This can be done either in the standard items, e.g. energy costs, or with the help of reserve items.

Based on the data resulting from our analyzes, it may also turn out that we should take actions such as raising prices in our organization, securing our business in the form of working capital loans, before e.g. liquidity loss occurs.

It is quite possible that in some situations, it is the analyzes accompanying the budgeting process that will also highlight opportunities for our organization and become an impulse for planning development investments (e.g. opening another production hall) or investments in technologies, e.g. optimizing current processes in the organization (e.g. robotization).

Step 3 - Monitoring

First of all to be able to monitor and keep an eye on the pulse... we need to know what to monitor. That is why it is such an important element of budgeting to write down the key assumptions in detail, in particular for the key determinants and items that gave rise to the greatest risks or opportunities for our business.

We based our scenario analyzes on expectations. Depending on the situation and position, they may turn out to be more or less accurate.

After carefully writing down all the assumptions for each determinant, it is necessary to plan cyclical monitoring of the assumptions and assigning monitoring activities to responsible persons. For example, if we assume in the budget that energy prices will fluctuate in 2022 in the amount of 120% of current energy purchase prices, and our scenario analysis shows that the increase in these prices will significantly translate into our business, then when the increase exceeds our assumed ratio of 120%, you should consider whether it will be necessary to perform step 4, i.e. update our budget. In particular, it is worth doing if we still have a few months of the year or if the deviation from our forecasts is significant.

Summary

It can be concluded that the above guidelines are obvious. Nevertheless, at the very moment of the budgeting process, which in the case of the present times, carries many associated risks with economic and tax uncertainty, it is worthwhile to systematize your knowledge and follow predetermined paths.

In the current economic climate, it is worth quoting Henry Ford's words - "More than anything else - preparation is the secret to success."

I believe that even if the organization has not budgeted its activities so far, in such a shaky economic situation, along with many uncertainties related to the announced changes in the New Deal, preparing a budget for 2022 and even forecasts for the coming years should be a must have for every owner and every board.

The safety and fate of our business largely depends on our ongoing monitoring of the economic situation and quick response to all unfavorable trends for the organization.

It may turn out to be very difficult, and I would even be tempted to say impossible, if appropriate analyzes, writing down detailed assumptions and then continuous or cyclical monitoring of deviations from assumptions will not be made in advance by designated responsible persons. The tool that brings us closer to this goal is the careful preparation of a budget for our organization.

Grażyna Sadowska – Malczewska
Managing Partner
PKF BPO Sadowska – Malczewska Sp.k.

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• A few words about budgeting for 2022.pdf [PDF]