1. Go Top-Down and Bottom-Up
It can be effective to come at budgeting from both the top and the bottom. So, starting at the top, as CEO it is your job to spell out your business objectives. You may be aiming to increase sales by 5% or increase profits by 15%. Whatever your goals, this puts a stake in the ground.
Now start from the bottom up. By this we mean get your managers and sales people (or you wearing your sales hat) to forecast revenue by client, by product or service and/or by geography. The more granular your sales forecast the more accurate it is likely to be. If you are planning to launch a new product or service, consider potential revenue by client or by salesperson.
Once a sales budget is established, then work out the costs to deliver the projected volume of goods and services and your ongoing overheads required.
If there is a difference between your business objectives (top-down) and the forecast (bottom up) budget, now is the time to start massaging things. What changes need to be made to your plans and forecasts to realise your objectives? Will a small price increase get you to your target sales increase? Are the costs of your new product launch preventing you from achieving your target profit levels? Should you delay launch or reassess your goals?
As you can see, the budget becomes an integral part of the planning process, ensuring that business plans are realistic and achievable.
2. Be conservative.
It’s easy to be exuberant about future plans, particularly if you are passionate about your business. But when it comes to budgeting it’s best to be conservative. The primary purpose of your budget is to ensure that you have enough money to stay afloat and do the things you want to do. Working conservatively safeguards your cash flow and avoids damaging business decisions.
3. Don’t Be Afraid to Use An Educated Guess
Many people have difficulty with the idea that a budget is an estimate, not a fact.
Your job is to be as educated as possible about your market, your competition, your suppliers, the economy and other factors that might affect your sales and costs. After that you have to be prepared to go with an “educated guess”.
As we point out in point 5, you need to keep reassessing this “educated guess” as the year progresses and more information becomes available. But don’t allow yourself to be paralysed by the fact that when projecting the future you will have to deal with unknowns.
4. Build in “What If” Plans
The sad fact is that even the most well researched budget is likely to be wrong. And that’s simply because none of us has a crystal ball, so the future will always hold surprises.
The best way to prepare for budget surprises is to build in “what if” plans or scenarios. You will have made some assumptions in putting your budget together. Now, have a look at what happens if those assumptions prove false. What if your biggest customer moves to a new supplier? What if your competitors cut their prices? What if an important supplier goes out of business? The what if’s you choose to analyse will depend on your assessment of the main areas of risk for your business.
5. Review. Review. Review.
Once your budget is set make sure you compare your actual performance against your budget every month and identify where these numbers varied. You will be able to identify problems and opportunities more quickly if you consistently monitor your progress.
Constant reviewing will also make you better at budgeting and better able to understand your business financially. In the long run this is likely to lead to more profits!
We are here to help! If you would like help with your budget process or the development of “what-ifs” please give us a call.