Setting a budget is one of the most crucial business tasks in running a business, as it establishes expectations and parameters for your business to operate within. If you do not set a budget, it increases the risk of failure and closure. Most companies that set a budget view it as just another administrative task and do not adhere to it because they do not recognise its value.
In this article, I will explain how to set and stick to a budget.
The first thing you need to clarify is that setting a budget is not a waste of time. A good budget helps you to prepare for the future and foresee problems before they occur.
The next task is defining your strategic objectives, and you need to understand where you want your business to be in the next 1,2 or 3 years. For example, if you plan to grow your business by 20% next year, your budget should accurately reflect this growth. Many small business budgets are based on past performance rather than strategic objectives.
The next stage is deciding how you will collate all the information. Budgeting should be a collaborative effort. You should obtain input from your managers regarding income, expenditure, and staffing in their respective departments. Department managers should also submit a “wish list” of expenses or new items that they would like to include in the budget, along with the benefits of these additions.
Key elements of a budget
The Sales and Marketing departments should work closely to give you a sales budget aligned with the marketing plan.
All staff-related costs should be budgeted, including allowances, taxes and their maximum bonus. Include any more staff as part of the wish list.
For small businesses, it’s best to analyse overheads for the whole business and then apportion the costs to other cost centres afterwards if required. Analyse what was spent in previous years and estimate how much you will consume next year for variable expenses. Agree on fixed costs, such as rent, insurance, and leases, before you commence your budget.
Ensure that you capture your capital expenditure (including equipment, property, fixtures, and technology) in your budgeting process. This should be captured as part of your cash budget.
This is likely the most crucial aspect of your budget. You need to determine if you have sufficient funds to sustain your business over the next year.
A cash budget takes information from the budgeted P&L and the Capital Budget to calculate your cash requirements for the next year. To improve the accuracy of the cash budget, you will need to make assumptions about how quickly your customers will pay you after a sale and how quickly you will pay your suppliers.
Once all the information has been collated, you need to analyse the entire budget and ensure that this reflects the business’s strategic objectives. As a business owner, you may need to make some difficult decisions that may affect how your business operates.
How To Stick To Your Budget
Setting a budget is easy. Sticking to it is the hard part. There is no point in going through the budgeting process if you don’t follow it. A budget is a roadmap to a business’s future. To ignore it means your business is at risk of going off course. Many business owners do not realise that budgets can be flexible; you do not have to follow them rigidly if circumstances change. Adding a level of business analysis and performance metrics is key to increasing flexibility in your budget.
Key metrics to add to your budget
Staff Cost %
How much are your staff costs about your revenue? Or in relation to your total expenditure?
Revenue Formula: [Staff Costs / Revenue]
Expenditure Formula: [Staff Costs / Total Expenditure]
Cost Per Unit/Sale
What is the cost to you for each unit you sell?
Formula: [Total Expenditure / Unit or Sales]
Marketing cost per new customer
Every business needs new customers. Therefore, you must budget how much you spend to get new business.
Formula: [Marketing Expenditure / New Customers]
Overhead %
How much are your overheads (running costs) about your revenue?
Formula: [overheads / total expenditure]
Gross Margin %
To calculate your Gross Margin, you must understand how much of your expenditure is directly related to making, delivering or selling your product/service.
Formula: [(Sales-Cost of Sales)/Sales]
Net Margin %
This is similar to Gross Margin %, but you should replace the cost of sales with total expenditure.
Formula: [(Sales-Total Expenditure)/Sales]
Using Budget Metrics to Control Your Business
Budgeting for these metrics helps you to rationalise the changes within your budget. For instance, if you win a new contract not included in the budget and require additional staff to fulfil the contract, you should proceed to recruit the additional staff. Still, you should ensure that your actual staff cost % remains at the budgeted level.
Your budget will also enable you to identify and rectify issues in your business. By analysing the P&L against the budget, you can analyse variances and rectify overspend. Variance analysis should also pick up underspends that can cover overspending, thus allowing you to stay within your gross margin % or net margin %.
This technique can also work for revenue. For instance, if revenue is down for a particular product, you can check if your marketing activity is at the required level by analysing the marketing cost per new customer.
Use variance analysis against the budget metrics to investigate potential problems in your business. For example, if your overhead spending % varies significantly from what is budgeted, it should be investigated.
You should review the actual performance against the budget on a monthly basis. Any changes in your budget should be recorded separately from your forecast.
Each time you update your forecast, you should note the reasons for the variance in the budget. This will enhance your budgeting process next year and help you maintain effective control over your business.
Make Your Business A Success
The key to a successful business can be found in our Business Success Formula. If you structure your business using the Business Success Formula as your blueprint, you will significantly decrease your chance of failure.
We assess your business and implement our business success formula through our Business Assessment Service, The Business 360. It provides you with all the information to 10x your business in weeks. You can check it out here.
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Kurt Graver is the founder and CEO of SGI Consultants, a business consultancy that has helped over 2,000 entrepreneurs establish successful startups using systematic business development methodologies. An accountant with an MBA and 25 years of commerce and consultancy experience, Kurt specialises in strategic planning, market analysis, and sustainable business growth