03 Dec Benefits of Planning – Last of a series
Key steps in drawing up a budget
There are a number of key steps you should follow to make sure your budgets and plans are as realistic and useful as possible.
Make time for budgeting
If you invest some time in creating a comprehensive and realistic budget it will be easier to manage and ultimately more effective.
Use last year’s figures – but only as a guide
Collect historical information on sales and costs if they are available – these could give you a good indication of likely sales and costs. But it’s also essential to consider what your sales plans are, how your sales resources will be used and any changes in the competitive environment.
Create realistic budgets
Use historical information, your business plan and any changes in operations or priorities to budget for overheads and other fixed costs.
It’s useful to work out the relationship between variable costs and sales and then use your sales forecast to project variable costs. For example, if your unit costs reduce by 10 per cent for each additional 20 per cent of sales, how much will your unit costs decrease if you have a 33 per cent rise in sales?
Make sure your budgets contain enough information for you to easily monitor the key drivers of your business such as sales, costs and working capital. Accounting software can help you manage your accounts.
Involve the right people
It’s best to ask staff with financial responsibilities to provide you with estimates of figures for your budget – for example, sales targets, production costs or specific project control. If you balance their estimates against your own, you will achieve a more realistic budget. This involvement will also give them greater commitment to meeting the budget.
What your budget should cover
Decide how many budgets you really need. Many small businesses have one overall operating budget which sets out how much money is needed to run the business over the coming period – usually 12 months. As your business grows, your total operating budget is likely to be made up of several individual budgets such as your marketing or sales budgets.
What your budget will need to include
Projected cash flow – your cash budget projects your future cash position on a month-by-month basis. Budgeting in this way is vital for small businesses as it can pinpoint any difficulties you might be having. It should be reviewed at least monthly.
Costs – typically, your business will have three kinds of costs:
• Fixed costs – items such as rent, salaries and financing costs
• Variable costs – including raw materials and overtime
• Capital costs – purchases of computer equipment, for example
To forecast your costs, it can help to look at last year’s records and contact your suppliers for quotes.
Revenues – sales or revenue forecasts are typically based on a combination of your sales history and how effective you expect your future efforts to be.
Using your sales and expenditure forecasts, you can prepare projected profits for the next 12 months. This will enable you to analyze your margins and other key ratios such as your return on investment.
Use your budget to measure performance
If you base your budget on your business plan, you will be creating a financial action plan. This can serve several useful functions, particularly if you review your budgets regularly as part of your planning cycle.
Your budget can serve as
• An indicator of the costs and revenues linked to each of your activities
• A way of providing information and supporting management decisions throughout the year
• A means of monitoring and controlling your business, particularly when you analyze the differences between your actual and budgeted income and expenses
Comparing your budget period over period can be an excellent way of benchmarking your business’ performance – you can compare your projected figures, for example, with previous years to measure your performance.
You can also compare your figures for projected margins and growth with those of other companies in the same sector or across different parts of your business.
Key performance indicators
To boost your business’ performance, you need to understand and monitor the key “drivers” of your business – a driver is something that has a major impact on your business. There are many factors affecting every business’ performance so it is vital to focus on a handful of these and monitor them carefully.
The three key drivers for most businesses are
• Costs or expenses
• Working capital
Any trends towards cash flow problems or falling profitability will show up in these figures when measured against your budgets and forecasts. They can help you spot problems early on if they are calculated on a consistent basis.
Review your budget regularly
To use your budgets effectively, you will need to review and revise them frequently. This is particularly true if your business is growing and you are planning to move into new areas. I recommend a monthly review of plan versus actuals and then update the rolling forecast every quarter. Using up to date budgets enables you to be flexible and also lets you manage your cash flow and identify what needs to be achieved in the next budgeting period.
Two main areas to consider
Your actual income – each month compare your actual income with your sales budget, by:
• Analyzing the reasons for any shortfall – for example lower sales volumes, flat markets, underperforming products
• Comparing the timing of your income with your projections
• Comparing your actual spend versus projected or budgeted spending
Analyzing these variations will help you to set future budgets more accurately and also will allow you to take action where needed.
The main thing to remember is that this process is important to the success of your business. Too many business owners spend all their time working IN the business and not ON the business. Investing the time to create a plan and a budget, along with a regular cadence to review performance, and adjust the plan will help to eliminate surprises, and allow you to RUN the business, instead of the business running you.
A Fractional CFO can help you with all steps of this process and keep you on the path to greater success and help you to meet your business goals.