There’s a lot about Budgeting that’s like taking a road trip.
Budgeting provides a window into your business. It’s also a steering wheel that you can use to direct energies and resources within your business.
Budgeting is also your road map, so you know where you are going. It gives purpose to your business and ensures there is a high probability your will be rewarded for your effort instead of just “hoping”.
It’s a sanity check: if you cannot produce the results on paper or see a road on the map, then your plans may not be realistic. Reporting against budgets keeps you in between the white lines on the road.
It also enables you to pause for a periodical review of actual results versus budget. Just like during a road trip when you need to stop, in order to refresh, recollect your thoughts and re-energise.
It’s no accident then, that every big business has an annual budget.
So why is it that almost every small business I meet for the first time, does not have a budget? Lack of planning and financial control, are listed among the prime reasons for the poor success rate of small business and there is no reason this should be the case.
Accounting software has made it so easy to create a budget in a very short space of time and to monitor progress against the budget in real time. (Find out more about Real Time Accounting).
This means small business has the ability to play with the big boys and plan and budget for growth in a cost effective manner.
Types of budgeting
There are a myriad of methods but here are some common business budgeting techniques:
- Aspirational (set sales or profit targets): Achievable results; constant input and management required
- Opportunity Cost: Take a look at your personal market value i.e. “What would an employer pay you, with full entitlements?”, and adjust this figure to suit your expectations and use this as a minimum profit figure to work the budget
- Cost control: Focus on controlling costs; especially important if dealing with fixed or limited income opportunities e.g. Grant funded not-for-profit or a start up.
- Feel Good: Generally under-budgeting potential; feel good factor when budget is achieved
- Unrealistic / “Shifting the Goal Posts” budgeting: This is budgeting that is not fixed, but quickly adjusted upward if the results are achieved or look like they will be achieved. Common for sales role positions and can be highly demotivating.
With the exception of the last method, all serve a purpose and can be created as follows:
Quick method for Setting a budget.
Start with what you know and the costs you can control.
- Export the previous 12 months trading history by month from your accounting software to Excel. If you don’t have a history, ask your accountant for one typical for your business.
- Identify and separate fixed costs (e.g. office/admin salaries, rent, lease payments, bank account fees) as well as the variable costs (merchant fees on sales, direct labour costs, marketing spend, etc.)
- Adjust fixed costs for inflation or information you know. For example “will be moving in October”. Here you need to add removals costs, legals and the new rent.
- Calculate each variable cost as a percentage of sales (for example direct labour costs = 30% of sales, merchant fees .07%) and attach formulae to adjust with changes in sales.
Next, ensure your budget reflects your business.
Review historical sales and look for seasonality, trends and one-offs and adjust accordingly. Allow for impacts of annual leave and variations in trading hours per month during periods like Christmas and Easter.
Once you have done this, we are ready for a bit of “What-if” analysis.
(Tip: learn about setting a Strategic Plan here)
Top to Bottom Approach (Vanity):
Pick a sales or income goal e.g. 20% growth in sales, 25% increase in number of customers, 40% increase in average sale value etc. (can have more than one goal) and let the results flow through.
Sanity check: Ensure profitability percentage is not adversely impacted and consider the cash flow required to fund growth. For instance, is there a mismatch between debtors payment terms at 60 days versus creditor terms of 30 days and weekly wage cycle?
Pick a goal, such as 50% growth in profit, $X profit figure, $X take home pay/owner. Let the bottom result flow up to the sales line
Sanity check: Break down the sales figures and ensure these are achievable. Again consider the impact on cashflow and if negative, how this may be funded.
Every large business has a budget and for very good reason. Accounting software has made budgeting assessable and cost effective for small business. I have seen some amazing results of clients “just putting it out there” and achieving their dreams as a result. The power of putting plans on paper cannot be underestimated.