Budgets
   

You probably will make the analysis of the income statement each month, or at least every few months. This financial information is useful also as a basis for preparing a budget for the coming year; the income statement is the starting point. You adjust the numbers on the historical income statement according to your best estimate of how revenues and expenses will differ in the year ahead.

If your first cut at such an estimate does not indicate that the entity is going to earn a satisfactory income, look at what needs to be done to correct the situation:

·Cut expenses? (But remember that there are limits to this strategy)  
·Increase advertising and other marketing expenses in order to generate more revenue?  
·Discontinue any activities not performing satisfactorily?  
·Find new ways to earn revenue?  

The point is that preparing a budget starts our thinking about what, if anything, needs to be done in order to produce a satisfactory income next year, and to take the necessary action ahead of time.

In many entities, managers expect that the historical income statement will "contain no surprises." The expected results are set forth in the budget and modified according to the manager's judgment on effect of changes in conditions since preparing the budget. With a well-prepared budget and a good feel for what is currently going on, the financial statements essentially confirm what the manager already knows.

In addition to the budget, you probably will forecast the entity's need for cash. The basic approach is the same as that already described, but in the annual exercise, you should consider alternatives with longer-run consequences. If the business is seasonal, for example, reviewing the monthly balance sheets may indicate a plan for borrowing in months of peak cash needs and for investing excess cash in other months.