Budgeting is one of the most important business tasks in running a business as it sets expectation and parameters for your business to operate. If you do not set a budget it increases the risk of risk failure and closure. Most companies that set a budget just see it just another administration task and do not stick to it because they do not see the value in it. In this article, I will explain how to set a budget and stick to it.
The first thing you need to get clear in your head 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, you need to understand where you want your business to be in the next 1,2 or 3 years. For example, if you are planning to grow your business by 20% in the next year your budget should reflect this. Too many small business budgets are based on past performance and not strategic objectives.
The next stage is deciding how you will collate all the information. Budgeting is should be a collaborative effort, you should get input from your managers with regards to income, expenditure and staffing in their respective departments. Department managers should also submit a “wish list” of expenses or new stuff that they would like to be included in the budget any the benefits of this.
Key elements of a budget
The Sales and Marketing departments should work closely together to give you a sales budget that aligns 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 then apportion the costs to other cost centres afterwards if required. Analyse what was spent in previous years and try to estimate how much you will consume in the next year for variable expenses. Agree fixed costs such as rent, insurance and leases before you commence your budget.
Ensure you capture all of your capital expenditure (equipment, property, fixtures and technology) as part of your budgeting process. This should be captured as part of your cash budget.
This is probably the most important part of your budget. You need to know if you have enough money 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 have to make assumptions on how quickly your customers will pay you after you have made a sale and how quickly you will pay your suppliers.
Once all the information has been collated you then need to analyse the entire budget and ensure that this reflects the strategic objectives of the business. As a business owner, you may need to make some difficult decisions that may affect how the whole of 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 the roadmap to a business 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. The key to adding flexibility into your budget is adding a level of business analysis and performance metrics to your budget.
Key metrics to add your budget
Staff Cost %
How much are your staff costs in relation to your revenue? Or relation to your total expenditure?
Revenue Formula: [Staff Costs / Revenue] Expenditure Formula: [Staff Costs / Total Expenditure]
Cost Per Unit/Sale
How much does it cost you for every unit you sell?
Formula: [Total Expenditure / Unit or Sales]
Marketing cost per new customer
Every business needs new customers, therefore, you need to budget how much you spend to get new business.
Formula: [Marketing Expenditure / New Customers]
How much are your overheads (running costs) in relation to your revenue?
Formula: [overheads / total expenditure]
Gross Margin %
To calculate your Gross Margin you need to 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 cost of the sales with total expenditure.
Formula: [(Sales-Total Expenditure)/Sales]
Using Budget Metrics to Control Your Business
By budgeting for these metrics helps you to rationalise the changes within your budget. For instance, if you win a new contract that was not included in the budget and you require additional staff to fulfil the contract you should proceed to recruit the additional staff but you should ensure that your actual staff costs % remains at the budgeted level.
Your budget will also allow you to find and rectify problems in your business. By analysing the P&L against the budget you can analyse variances and rectify and overspend. Variance analysis should also pick up underspends that can be used to cover overspending thus allowing you to stay within your gross margin % or net margin %.
This technique can work for revenue also, for instance, if revenue is down on a particular product you can check 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 spends % varies significantly than budgeted it should be investigated.
You should review actual performance against budget every month. Any changes in your budget should be recorded separately as your forecast.
Each time you update your forecast you should note down the reasons for the variance to the budget. This will not only improve your budgeting process next year but will ensure you keep good control over your business.