How do you ensure that expenses do not exceed income? The solution seems simple: set the level of planned spending and control the execution. Corporate budgeting, as it is referred to, is a financial planning process that involves forecasting an organization's revenues and expenses for the coming period, usually a year. It is a key element of financial management that enables companies to control their finances, supports strategic decision-making and helps achieve business goals.
ENERGY COST BUDGETING
For industrial organizations and various types of institutions, budgets and the entire budgeting process play an extremely important role. They serve as a key tool both for internal management needs and, if necessary, for external communication. Internally, budgeting allows managers and employees to accurately track financial flows, identify areas of cost optimization and monitor the effectiveness of ongoing projects. It's also a way to assess the profitability of operations and ensure that all expenses are justified and contribute to the value of the company.
Externally, budgets can serve as a way of presenting an organization's financial stability and credibility to investors, lenders, business partners or regulators. For them, an effectively developed and managed budget provides evidence that the organization has a solid financial foundation, which can make it easier to obtain external financing or build positive business relationships.
In the context of energy procurement, the budgeting process is not significantly different. Although planning energy expenses may seem complicated to newcomers, there are logical steps and guidelines to make the task easier. Following the following tips can make the process simple and even enjoyable.
We probably don't need to remind anyone about the value of controlling energy costs. Many of us became acutely aware of this, especially at the beginning of the energy crisis caused by the war in Ukraine.
We have already written about how to scrupulously check invoices in our article How to control energy costs in a company.
In another article, however, we presented ways to optimize energy invoices and the possible savings from doing so - Optimizing a company's charges for electricity and natural gas.
In this article, meanwhile, we will take a closer look at issues related to budgeting electricity and natural gas costs.
We will present different approaches to budgeting, consider the impact of the budget on other decisions in the company. In addition, we will give you tips on how to get down to budget development and prepare a checklist for efficient budgeting work.
Approaches to Budgeting Energy Costs
When budgeting energy costs, it is important to remember that we budget for commodity and supply (distribution/transmission).
Unfortunately, not everyone keeps this in mind and simply assumes some change (increase or decrease) for a single averaged rate covering both commodity and distribution. Such an approach can prove to be quite risky and can ultimately lead to quite a surprise that we have missed our forecasts by a large margin.
Why does this happen? As a rule of thumb, we budget too optimistically, or take prices that are too exorbitant in relation to the actual market situation. When budgeting, we often overlook charges that disappear in the following year, or those that are expected to appear as a new item on the invoice for electricity or gas distribution.
Energy Cost Budget - "On the Fast Track."
"Give me a price to budget for energy". - is a common question asked of purchasing department buyers by the controlling department in many companies. Most often, this type of question occurs in the last 4th quarter of the year, around October, when the budget for the following year is usually planned. The buyer makes what he believes to be an "expert assessment" and forecasts, for example, a 10% year-on-year increase in the price of energy or natural gas, and the topic is theoretically settled.
In this method, it is very difficult to defend the projected increase or decrease in the price for electricity or gas, since no assumptions are made as to what such a change would result from.
Energy Cost Budget - Precise
Given the fact that we are budgeting both the price of active energy and the cost of its distribution, it will be important to break down all the elements into factors and estimate or take already known values of the individual price components. Here, too, we can make the mistake of being too optimistic or too pessimistic about future energy prices. Let's remember to adopt sensible safety buffers.
For example, if we assume too narrow a safety corridor for the price of active energy or for gaseous fuel, we will be forced by such a situation to secure 100% of the price in case of a rapid price increase, because the market just went up the day after the budget was set. For this reason, it is advisable to take into account historical changes in the price of a particular component, the inflation rate or other information that comes from the energy and natural gas price market.
How to budget for energy costs and what decisions come out of it?
When it comes to budgeting for energy, as with other cost categories, you need to be aware of the rules operating in your organization: what decisions will we have to make when energy prices approach our budget level? Are any deviations from the budget acceptable? If we have any buffer, what impact will this have on the operation of our company?
In some companies, energy costs are not budgeted at all. We are talking about situations where practically the entire cost of energy is reflected in changes to the terms of that company's commercial contracts with its contractors. The budget then is only a certain cost estimate, but it does not force certain purchasing decisions when prices approach certain levels.
How best to prepare for creating a budget?
Wanting to go smoothly through the process of creating a budget, it is worth preparing all the necessary information in a structured form. It will be necessary to discuss this budget with key stakeholders. For example, it is worth reviewing the production plan so that it is easier to determine the amount of planned consumption. It will also be necessary to estimate acceptable safety margins for the price of gas fuel and active energy in case of significant changes in the market. Also keep in mind possible changes in distribution fees. It will also certainly be helpful to develop a logical spreadsheet that will allow us not only to make an initial estimate of the budget, but also facilitate subsequent updates and ensure proper monitoring during the fiscal year.
Below is a checklist to help you work on your budget:
- POWER AND GAS PURCHASE AGREEMENT - Check your contract for the purchase of electricity or gas fuel.
- PRICES - Determine your existing price protection level for the year for which you are developing a budget.
- MARKET VARIABILITY - Determine the margin of safety for the portion of the price that has not yet been hedged; while doing so, also examine the current wholesale price level for the products that will make up the price.
- DISTRIBUTION - check the current distribution tariff for each point of consumption; take into account possible rate changes resulting from the current energy law or other regulatory acts.
- INFLATION - check the inflation rate and include it in budget planning.
- CONSUMPTION - determine the planned energy consumption for the fiscal year.
- ASSUMPTIONS - make a note of all assumptions so that you can track what the various rates used to develop the budget were based on in the future.
- BUDGET TABLE - develop a spreadsheet with the budget and assumptions; a good table will allow you to prepare subsequent versions of the budget if your company's assumptions change and the market situation changes.
Following the above tips and approaching this task methodically by breaking down the cost of energy into individual components, it will certainly be easier not only to prepare a budget plan but also to carry out ongoing control of its implementation during the year.
BUDGETING ENERGY COSTS - Summary.
Beneath the control of electricity and natural gas costs lies the key to effective financial management in both households and businesses. Our approach to budgeting, while it may seem complicated, is essential for avoiding unforeseen expenses and maximizing potential savings. We have outlined two main approaches to budgeting: "on the fly" and "precise," with an emphasis on how careful analysis and strategic planning can significantly reduce financial risk. In addition, we highlighted the importance of being aware of the organization's operating principles and possible scenarios that can affect budgeting decisions. Our checklist for budget preparation is designed to streamline the process and ensure that all key elements are covered, allowing for flexibility and adaptation to changing market conditions. Remember that success in budgeting for energy costs depends not only on accurate calculations, but also on continuous monitoring and adjusting plans to the current situation. Let's remember that our budget will be sensitive to many external factors affecting the economy at all times.
Author: Wojciech Nowotnik
