Many business owners do not create a budget, either because they don’t know how or because they do not consider it worth their valuable time. This is unfortunate because a well thought-out plan can help you control spending, ensure that resources are available for those things that support business growth and development, and allows you to identify cash flow problems and other bottlenecks before they can harm your business.
There are a number of good reasons for creating a budget:
- To set targets
Every business needs targets, otherwise it has no measure of performance, and no means of distinguishing success from failure. A budget will project both revenues and expenses in order to determine both its short, and longer-term, strategy. By focusing on the essentials, and restricting time and money spent on items that are not in the plan, you can ensure appropriate resources are available to support the objectives of the business.
- Strategy requires funding
Strategy and planning are integral to one another. A budget helps achieve strategic and operational goals by ensuring that money is allocated to those things and activities that support the strategy – for example, the launch of a new product or service.
- To set priorities
A well-structured budget helps identify business priorities and communicates them to a broader audience, both within a company, and, if shared with potential investors or lenders, externally as well. Business owners can help employees understand the company’s strategy, and how the annual budget funds these priorities. In the case of lenders and investors, a budget demonstrates that the business has defined its objectives, identified priorities and allocated resources accordingly. In other words, it helps build credibility and trust. A potential investor is much more likely to lend money to a business that has a budget, than one that does not.
- Helps control spending
The production of any budget involves discussions about spending priorities and cost control which is a healthy dialogue for any business to engage in, providing that the dialogue is constructive. When funds are allocated, spending is controlled, and a measure provided as to what is an acceptable level of cost in the business. By focusing on the implementation of the budget, unplanned spending can be reduced to a minimum.
- Identifies major capital expenditure and other large ticket items
An effective budget identifies the need for capital investment and other large one-off items, and make sure funds will be available and allocated to fund their purchase. It also reflects complementary activities – for example, if you plan on having 3 new staff you might need to buy 3 new laptops for them to use.
In terms of how you create your budget, there is no need to make it too complicated – what you are trying to determine, after all, is what you are likely to earn, and spend, in the next financial year.
Your starting point should be to collect information on past sales and costs. These should be as accurate and complete as possible as they will be the basis of your plan. If you have employees, ask them for input on their relevant areas of operation; not only does it help give you as full and accurate picture as possible, but involving them helps their engagement and buy-in to the budget process and objectives. They may also be able to offer ideas as to how costs could be reduced or sales boosted, which, in turn, could lead to you amending your budget to reflect their input.
The next step is to consider what changes have occurred, or are likely to occur, which will impact your future plans. For example, has the competitive landscape been changed by the entry of a new aggressive, low-cost competitor. Have their been changes in the industry more broadly, due to the introduction of new technology, or increased regulatory requirements? How have your resources changed and how has this impacted your ability to supply your products or services?
Having got this information, prepare your sales forecast, allowing for any business seasonality, or any other significant fluctuations, such as the impact of a large one-off contract.
Turning to the cost side, work out first your fixed costs – those business overheads which will be incurred regardless of your level of activity. These might include salaries, rent, utility costs, IT expenses etc. Then calculate your variable costs – those expenses which vary depending on your level of sales. These might include materials, labour (including staff overtime), the hire of special equipment to fulfil an order etc. Finally, include any non-operational costs – these might include bank charges, interest, tax and VAT payments.
Having collected all your data, everything should now be consolidated, either in a spreadsheet or, if your accounting system supports it, within an applicable budget template.
Once your budget has been prepared, sit back and review it with a critical eye. Is it as realistic as possible and is it achievable? Whilst an over-optimistic sales forecast or a predicted fall in costs may look good on paper, will they materialise in reality? A too optimistic budget can cause you to expand too quickly, or run into cash flow problems. So, if need be, build some conservatism into your estimates, or create another version of the budget which reflects more of the downside risk.
Finally, while the budget is a very good tool for planning and managing your business, it is normally created at one point in time. Events and market fluctuations may cause fundamental changes to the business assumptions on which it was based. Update your budget accordingly, or prepare a forecast which reflects the changes in assumptions, realignment of priorities or amended targets.
Budgeting is an essential element of business success, as it helps with both planning and control of an organisation’s financial and other resources. Business planning involves decisions about strategy and identifying priorities, while controlling ensures plans and objectives are achieved and managed. Managing a business without a budget is like leaving home with no idea of your destination. If you embark on a journey with no plan as to where you are going, how do you know when you’ve got there?