When you opened a small business, did you dream of how to create a budget?
What about writing up a business plan or balancing the books, reconciling your balance sheets, and pouring over profit and loss statements? Likely not! Most entrepreneurs are impassioned about an idea, or long for the freedom of being their own boss. But, like it or not, budgeting is a critical component of any efficient, effective organization. Why is it so important – and how do you learn to prepare a sensible budget?
Business Budgets Matter
From “I’m too busy,” to “It’s too complicated,” small business owners or managers can come up with a variety of excuses as to why they do not budget. But as many excuses as there may be, there are an even greater number of benefits to budgeting:
- Help in controlling finances.
- Reducing uncertainty and helping your anticipate future cash flow needs.
- Proactively preparing for challenges and problems.
- Improving your ability to control the business.
- Increasing ability to handle change.
- Facilitating better, faster, decision-making.
- Clear communication of your goals and priorities.
- Ensuring you have enough money for strategic project and initiatives.
No one can see into the future, but with a solid budget, owners can prepare for whatever tomorrow brings. A number one key fact is that if you actually have a plan and you stick to it you have a much higher chance of success than you would if you had no plan in place.
How to Create a Budget
Get the Right People Involved in the Process
Share important information and gather the input of employees or managers who are responsible for major business functions, such human resources, marketing, purchasing, etc when you want to create a budget.
- This will help you achieve a ‘big-picture’ view of your organization, its needs, and areas where you need to invest or cut costs.
- Make sure that they report relevant budget information in a timely, accurate manner. You may use simple spreadsheets or invest in specialised budgeting software (an investment in which you will see a great return as you save time – and money).
Use the Previous Year’s Figures to Guide Your Budget
This will enable you to see exactly how much revenue you have generated in the past, as well as how much you have spent in each area of your business. Use this to guide your predictions about the future.
Given your sales history and how robust you expect next year’s sales to be, you can create fairly accurate forecasts. Take into consideration the following:
- The pricing and marketing strategies you use.
- Changes in your market and in your competition. (e.g. is price trending down?)
- Changes in your business. (e.g. launching new products; retirement of an old product).
When forecasting revenues, think about cash flow. For instance, how long will it take for customers to pay you? How much do you need to allow for bad debts or failure to pay?
Also think about when you need to pay your suppliers and vendors. When do you do this? Will you buy on credit? Will you pay in advance? Have a contingency for late payment.
One of the biggest known challenges to SMEs is simply getting paid for work completed when invoicing. Around £67bn is owed at any one time to small UK businesses according to the Asset Based Finance Association (ABFA). You can ensure you have a drawdown facility from your invoices to suit your needs by using Invoice Finance.
By using invoice finance to keep cashflow correct your business is free to grow in line with your ambition and company turnover whereas an overdraft will typically advance 30% of turnover. Remember you can compare every known invoice finance deal in the UK.
What fixed costs do you have (e.g. rent, mortgage, salaries)? What variable costs will you incur (e.g. supplies, materials, subcontracted labour, utilities)? Analyse historical costs records, and then contact key suppliers or vendors for quotes. Do they foresee having to change their prices? How can you prepare for unanticipated price fluctuations? You can minimise the risk here by signing long-term supply contracts or buying insurance to protect against possible disasters that will affect costs. Remember to have a contingency plan in place.
Create Profit and Loss Budgets and Balance Sheets
Create profit and loss budgets: this will reflect your projected profits for the year. These documents are helpful because you can analyse projected margins. If they are too thin, you can decide on pricing or cost reduction strategies. Another key step is developing a balance sheet, which includes capital expenses (e.g. new equipment) less disposals and depreciation. The balance sheet helps you analyse stock turnover, working capital, and financing obligations (e.g. loan repayment). Prepare a budget for 12 months, but don’t let it collect dust. Check back monthly to enter in actual income and to see if your forecasts and the current state of your business align. (In preparing P&L sheets, balance sheets, and conducting comparisons, software can be a tremendous, and time-saving, help.)
Use Your Budget as a Tool
You can use your budget to help you monitor costs and revenues, particularly as they relate to specific activities. They also provide you with invaluable insight that can help you make more informed, strategic decisions. Two areas to which you want to pay special attention are:
- Actual income. Compare forecasts to actual income each month and conduct an analysis. Is there a shortfall? Why? Were sales lower than thought? Did products not perform as well as you’d expected? Was income higher? This could mean your targets were too low. You can take action where needed and amend the budget going forward to obtain a more accurate version.
- Actual expenditure. What are you spending versus what you thought you’d be spending? Did fixed costs differ from your forecasts? Are variable costs in line?
Budgets may seem intimidating. If you need help, ask a professional accountant or a business advisor. Software can be a simple and relatively low-cost solution. Budgets are too important to neglect and remember something is better than nothing.