No matter how small your business, having a working budget is critical to good financial management. We see too many businesses fail simply because they didn’t have an adequate handle on their financial situation.
If you didn’t set a budget at the beginning of the year it’s not too late to start. If you did set a budget then when’s the last time you got it out of the drawer?
Here are our tips for setting and managing your budget better.
Start with Expenses
One of the most common budgeting errors is missing or underestimating expenses, so we suggest you start your budgeting process with a detailed review of past expenses and estimate of future expenses.
Recurring monthly expenses are fairly easy to budget. For variable costs such as meals or entertainment use averages for the previous 12 or 6 months to estimate costs going forward. Don’t forget about quarterly and annual expenses such as insurance or utilities. If you are uncertain about upcoming costs, contact the suppliers you expect to work with. And finally make sure you allow for purchase or replacement of capital items such as computers. We suggest you build in an annual allowance for depreciation to cover these costs.
Make sure you divide your expenses into “cost of goods/services sold” – those costs that will fluctuate depending on your sales, and “overheads” – those costs that are largely fixed regardless of fluctuations in sales.
Understand Your Breakeven
You can make assumptions for future revenue based on recent trends. If you are a start up or plan to launch a new initiative in the period ahead you will have to make assumptions based on your knowledge of the industry and competition.
Whichever way you estimate revenue, it is important that you understand your breakeven point. This represents the amount you will need to sell to cover your overheads. Selling below this point will result in losses and above this point will realise profit.
Understanding your breakeven will highlight financial vulnerabilities and enable you to make informed decisions. So, for example, if your estimated sales are running close to your breakeven point this means that a slight hiccup in sales could push you into a loss position. You may want to consider tightening up on your costs as protection.
Put simply, you can calculate your breakeven by dividing your overhead costs by your average gross margin. So for example if you have $100 in overhead costs and you earn on average $20 per item sold, you will need to sell 5 items to achieve breakeven. This is a simplistic view and most companies will have a number of complexities to consider. Please contact us if you need assistance in calculating your breakeven.
Factor in Industry Standards
When you are establishing your budgets it can be valuable to look at industry standards as well as projections based on past results. Industry benchmarks may highlight areas where you can improve in the year ahead. So for example, if the average gross margins in your industry are considerably higher than those you are achieving there may be opportunities for price increases moving forward.
We subscribe to benchmarks across a wide range of industries. Please let us know if we can be of assistance.
The future is unpredictable – which is what makes budgeting so difficult. We recommend that you err on the side of caution when budgeting to ensure you don’t overcommit your business. Don’t simply assume that your sales will steadily increase – consider the possibility that clients may fall by the wayside. Allow for unexpected cost increases.
If you are a natural optimist and find it difficult to be conservative then we suggest you consider running two budgets: an “expected budget” and a “worst-case budget”. The “worst-case budget” will help you to put in place emergency plans if the worst happens.
Review Your Budget Monthly
Your budget is not going to work for you if you simply put it in a drawer and forget about it. We recommend you review your performance against your budget every month and be prepared to tweek it (or radically change it if that’s what’s required). Take a look at your pipeline and consider modifying your sales projections. Are you going to need to change your staff numbers? Are your expenses coming in as expected?
You are going to make mistakes with your budget – that is a given. You are a business owner not a psychic! By making adjustments throughout the year you will stay in control of your financial situation – and you will probably build a better budget next year.
We strongly encourage all our clients to establish and regularly review a business budget. If you need help getting started, or at any stage in this process, we are only a phone call away.