Budgeting - putting your business plan into figures

 20071001
The idea of working to a budget is foreign to most SME owners - that's something that bigger companies do. Maybe they'll need to develop one when their business grows but meanwhile it's altogether too time consuming and would keep them away from the "real" work. That thinking may need a little revision. The fact is, businesses that don't operate to a budget are unlikely to grow.

Business owners who take the approach that budgeting isn't for them can be seen plugging away week by week and month to month working out what they need to do with their revenue as it comes in to meet immediate needs: is it a pay period?; will it cover the electricity account?; is more inventory needed?

In developing a budget for your business you reverse this approach and take some control over the whole process. Instead of working with whatever amount happens to come in each month you start with planning, for the year ahead, just how much it will cost to run the business. Then estimate how much revenue will need to be generated through sales in order to cover those costs, pay you a salary, and still have a bit of profit left over. A budget has been described as a business plan expressed in numbers. At its simplest it looks like this:

Estimated Sales minus Estimated Expenses = Profit (or loss)

In developing projections for a year ahead you will be working in the dark to a certain degree, but anyone who has been in business for a couple of years will have the financial records to make a reasonable forward prediction of their sales and expenses based on averaging past years.

You might call this your "no-growth" budget - you have estimated just the minimum necessary to keep the business operating.

If you are interested in growing the business though, you start with working from the other end of the equation and setting the profit margin you would like to (realistically) obtain. Once a profit margin figure for the year has been decided a whole series of planning decisions cascade out from that: is extra inventory required?; will you need to put on more employees or move to bigger premises?; will you need to put more resources into marketing? All of these add to the Estimated Expenses part of the equation. To cover them and achieve the desired profit there needs to be extra Estimated Sales.

If your aim is business growth, the starting point is to build a sound estimate of the extra cost and of the extra sales revenue necessary to cover those costs so as to reach the desired profit. These things can't be left unplanned, the costs and sales merely guessed at, or the whole growth project will operate haphazardly and you may out-spend your revenue and put yourself out of business.

Budgets are usually created for a twelve month period with month by month estimates of sales and costs. That provides for including expenses that come up only once or twice a year, such as insurance, and spreading their cost out over several months. In this way you can plan ahead for the expense by trying to achieve enough sales each month to have the amount available when payment comes due.

As you conduct business during your budget year you compare your actual figures to your budgeted figures. This needs to be done month by month and requires some discipline but the payback is worth it. It will allow you to manage your spending so that you don't over spend and cut into or eliminate your profit. You will also be able to see if sales have met projections and will cover expenses. Where there are variances, ask yourself why the numbers are different. If some of your expenses, for instance, are higher than you expected, do you need to look for ways to cut them, or did business increase more than was expected and so add to your variables? If sales aren't on track, what has happened to cause the difference and how can you improve them? Or would it be more realistic to accept they will remain low and trim future costs to match?

Budget variances can be either warning signs or opportunity signals and the information they provide should be used constructively to decide where changes need to be made in operations to reach your budget goals. Alternatively, if you regularly fail to reach your monthly estimates your budget figures are a warning to pull in spending and set more realistic income goals.

Having a budget means having some control of your finances in advance. Setting the standard for your spending against expected revenue and having a tool to compare the expected figures against the actuals each month will give you a way of monitoring and changing plans so as to stay profitable. At the very least it will give you an indication of whether or not your business is profitable or just busy.

When you work to a budget you have one of the most effective management tools of all - a benchmark that you can use month by month to check your progress towards your business goals.

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