Most small business operators do not bother to plan and draw their budgets. This is dead wrong. As most businesses have a financial year that begins in January and ends December, this may be your last chance to ensure that you draw your next year’s business budget.
Importance: Your budget makes it possible for you track your cash/bank positions, business expenses, revenue levels and other key financial details. Overall, your budget does at least four things for you:
- It forces you to think through what opportunities and threats your business faces (thereby working to seize or address them),
- You are clear about what assumptions you are making in respect to your business and the economy at large,
- You are able to set targets and arrange to raise and deploy required resources to achieve the targets. This is key to business planning,
- At the end of the exercise, your budget becomes a standard against which you measure your business performance. And this is key to control.
If you fail to draw to draw your budget diligently, this may actually be an indication that you lack the discipline required of business commitment and execution. The negative consequences will be several and severe. From inability to see and seize opportunities, to risks of outright bankruptcy. Your budget is really like a road map for your business. It shows you know where are headed to and how you plan to get there.
Understand Financial Accounts: First, as an entrepreneur, you have to be comfortable and versatile with financial records. You have to have an excellent understanding of cash cycle and cash flows, profit and loss statements, and balance sheet, as well as the various accounts that make them up.
Typically, your annual budget will comprise of daily, weekly and monthly targets. All relevant accounts such as sales, cost of goods sold, various overheads etc will all be fully estimated. Similarly asset and liability accounts will also estimated at the end of each budget period. At the end of the exercise, your annual business budget should project the following:
- Estimate your profits for the period(s) (this will be by way of your profit and loss statement),
- Changes (increase and decrease) in assets and liabilities, (to be reflected in your balance sheet), and
- Cash flow (in a cash flow statement).
Two things are very important in planning your business budget, viz: Details and Process.
The Details:
It is important that you are very clear about the status of your business and the state of the economy within which you are operating. Research, therefore, is an integral part of the budget process. For instance what is the overall consumption of your product in your local economy and market? What is the national and local demand of your product? What is the production capacity of all operators? Is there a supply glut or excess demand? What are current interest and exchange rates? In what direction are they headed? How do they affect my costs of production? What will be the impact on prices and consumer behaviour? What will be the impact of possible new government regulations?
Assumptions: Projecting into the future always require certain assumptions to be made. With all the information you collate for the budget, you will therefore need to make very realistic and sensible assumptions. As optimistic as entrepreneurs always tend to be, it is important to be cautious when making assumptions. For instance it is much safer to overestimate costs than to underestimate them.
The Budget: As mentioned earlier, your budget will comprise your revenues, costs, and profits. It should also include a your cash flow. Yearly budget should therefore be divided into twelve monthly estimates in columns. Two blank columns should be included next to each. This is to allow you complete actuals in one of the blank columns and the variance in the other, at the end of each month. Simple accounting softwares are now available to enable you do this and get relevant metrics derived therefrom as well. You could also use Excel to draw your budget.
In drawing the budget, sales (and other revenue sources) are fundamental. It is therefore important that these projections are as accurate as is possible. Consider your previous year’s sales to come up with what is realistically achievable whilst at the same time it ‘stretches’ your teams to do the best possible. For a start up, your experience and knowledge in the business as well as research should guide you. You should also consult with professionals and other operators to gain as much insight as possible.
Next you will need to estimate production costs and overhead expenses that will be incurred in achieveing the proejected sales reveunes. Consider current costs, inflation, regulations and other relevant factors in making these estimates. In estimating your costs, an understanding of types of costs and their composition is very important. Some costs are ‘fixed’ whilst others are ‘variable’ or ‘semi-variable’. Each of these classes respond to sales and production differently. We have covered the behaviour of costs in our previous post on Cost Control.
Making profits is primarily one of the ultimate objectives of being in business. You have to establish how much you could make, in profits, from the information already gathered above. Sometimes obviously, losses are made. It is important to understand when losses are ‘expected’ and when ‘they make sense’. In both situations however, there must be a plan to reverse them into profits over a period of time that is reasonable and can be survived by the business. Making profits, however, is sometimes just the beginning of another challenge. Utilisation. Into what use do you put part or whole of your profit? Do you need to buy more equipment? Do you need to open more outlets? Do you need to pay more bonuses to your employees or dividend to your shareholders? Ultimately, you want to make the choices that offer the most chances in creating more and lasting value.
The Process:
Generally, you and the senior people in your organization are the ones responsible for drawing up the budget. However, even junior staff responsible for units should be carried along and definitely managers heading departments should be involved. This is to ensure that their inputs are taken into consideration and where compromises are required. When people are not involved or at least carried along during the budgeting process, it becomes more difficult to get their full buy-in in its implementation. A psychological indifference could become a source of drag in their behaviour and even apathy.
Involving all key people is one thing. Another issue is making out the time required. If your financial year begins in January, you will need to start your process latest in September of the current year. The objective should be to complete the process and adopt the budget at least two weeks before the year end. It is empowering for every responsible officer and his unit or department to close the current year knowing full well what their coming year budget is. At any cost, you should never allow your budget process to ‘spill’ over into the coming year. First you loose time (in the new year when people do not even know what is expected of them) and equally more importantly, you send wrong signals to your people that you are not serious about the budget or implementation.
Timing: Most small business operators know that ‘time is money’. However, many really do not understand what this means, and that affects their budget planning and business survival. For instance collecting your credit payments on time and as when due, will either reduce your interest expense (if you are borrowed) or earn you interest in the bank (if you are not borrowed). Deferring payments, on agreement and without jeopardizing your credit, will enhance your cash flow. Make the best use of your time and your finances will soar over time.
Review your budget periodically: A production unit head must monitor his output budget quite literally on a daily basis. The sales unit team should review his sales target on a weekly basis whilst the corporate executive should assess their performance vis-à-vis their budget on a monthly basis. The important issue here to note, is that depending on the responsibility level, periodic budget reviews are necessary. In addition to being able to assess how the business is doing, you will also have the opportunity to make sensible adjustments as may be necessitated or required.
Budget limitations: As with all endeavours to do with predictions involving human nature, it is almost impossible to be ‘exact’. Nonetheless, the benefits of a diligent budget planning, makes it completely necessary. As you develop the skills with time, you are likely to become more proficient and realistic. Understand these limitations and keep improving. The knowledge gained year in and year out should be fully internalised in the organisation.
No matter your business size, you should inculcate, in yourself and your team, the discipline to draw up annual budgets. Next challenge is also to ensure that you all work towards achieving the targets set. Working with your team for two consecutive years in drawing budgets, and regularly reviewing them will offer so much benefits. You will all learn to be better in drawing budgets, develop further camaraderie as you argue and negotiate issues out. And most importantly, you will learn how to follow a ‘road map’ to achieve business objectives.
