The best small businesses have a robust budgeting process in place which helps them:
- Understand how the business plan translates into money terms
- Identify any cashflow problems
- Raise funds to address investment or working capital needs
- Ensure that commitments to lenders and investors can be met
We offer below some suggestions about building a robust budget for the small business, based on our own experiences.
Choose the right time period
What period should the budget cover? And should it be broken down into weeks, months, quarters? These questions should be decided at the outset.
Make sure the opening position is correct
Unless your business is completely starting from scratch, there will already be assets and liabilities on day 1 of your budget that you’ll probably need to take account of, if the goal is to produce a credible, realistic budget.
A budget is meant to provide a realistic view of where the business is heading, against which progress can be measured, so be realistic about the assumptions made with regard to revenues, costs, spending plans etc.
Carve up your revenues by individual product/ service lines
Where your business supplies a range of products or services with very different margins or other very different characteristics, these should be recognised individually in the budget if failing to do so would result in significant inaccuracies.
Add in direct costs
Build in the direct costs of sales using assumptions that are realistic and consistent with the assumptions made elsewhere in the forecast, for example about sales volumes and margins on individual lines.
Understand your margins
Understanding gross margins is key. Ensure your budget reflects sensible profit margins.
Build in seasonality
If your business is very seasonal, it makes sense to reflect that in the budget. Seasonal variations can have a major impact on cashflow.
Adjust for inflation
Remember to adjust the figures for the effect of inflation and known or anticipated rises in costs. If you are striking contracts far in advance, use known figures wherever possible.
Base overheads on last year
It may be sensible to base budgeted overheads on last year’s actual figures, however do consider whether this is appropriate. If there have been major changes in circumstances, for example occupying new business premises or taking on additional back office staff, overheads may be materially different from previous years.
Consider the impact on revenues and costs of internal events and external factors
Think widely about what other events or factors might impact on the budgeted figures. Has the business made significant investments that should lead to improved productivity or new revenue streams? What are competitors doing and how might this affect sales volumes or pricing?
Don’t forget the impact of taxation, especially VAT, PAYE and corporation tax
Taxation will have a major impact on profitability and cashflow, so the major tax impacts need to be quantified and built in. Speak to your accountant if you need help.
Understand that profits and cash are not the same thing
A truly comprehensive budgeting process recognises that profits and cashflows are, almost always, not the same thing. Understanding the impact of budgeted activity on cashflows is critical for many organisations.
Build in planned investment
Whilst the temptation may be to focus on revenues and running costs, any planned investments should be factored in too; if equipment needs to be acquired, or funds need to be lent to a subsidiary company, or extra stock needs to be acquired, what will the financial impacts be?
Remember to factor in loan commitments
The business may have existing loan commitments or anticipate taking on new ones. The budgeting process should recognise such commitments and help you assess whether the business can meet continue to meet them.
Build in returns to shareholders
If dividends are planned, these should be built into the budget too. The budget would need to show that there are sufficient profits and cash available to meet planned distributions.
Do a sense check – what are the implications of your draft projections?
Having drafted your budget, it can be helpful to ‘stand back’ and consider the overall picture in the round. Does it stack up? What is it telling you about your plans, and do you need to adjust your strategy or be having conversations with lenders or other stakeholders? Do you need to test alternative scenarios?
Your budget provides a useful benchmark against which you can then measure actual performance. By periodically reforecasting the numbers based on actual experience, you can continue to ‘look forward’ and identify any further actions that may be necessary.
These days there are fantastic products available to help small business owners put this all into practice. The days of using complicated spreadsheets for budgeting purposes are, for many, becoming a thing of the past, with products like Futrli offering more efficient and visually appealing ways to build budgets, test scenarios and monitor actual performance. For a free demonstration of Futrli, contact us today.