Part Time FD Advice: Business Budgeting For Beginners

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Business Budgeting For Beginners

I was reading a short article in a magazine today focused on a high profile businessman. One point that really caught my eye was when the business owner stated that his company’s turnover would be between £10m and £20m this year.

For a growing company, or in an uncertain economy, some degree of variance is to be expected. But I’d be concerned if the sales performance of my company could vary to that extreme.

Whatever the realities, budgeting is a key tool that every business owner should be using to grow their business. Not bothering to budget is a big mistake that too many make.

The benefits of a trading budget or forecast are twofold.

  1. It sets an expectation or target to aim for and actions to focus on. Also what resources – people, premises, customers, supplies, funding – are required to make the forecast a reality.
  2. It provides a benchmark against which to monitor progress.

If all is going to plan, then great. If not, benchmarking actual performance against budget lets you quickly identify where the main variances lie, and react accordingly.

A simple budget boils down to only three elements: Sales turnover, Direct costs, Overheads. The budgeting process for each is set out below.

Budgeting Sales Turnover

Many small business owners think working out the top line sales figure is so difficult they don’t even attempt to put together a budget. “Our business is too unpredictable” is something I often hear. But this is not a valid excuse.

Working out a simple sales forecast is about making an informed judgement as to what sales next year will be like compared to sales in prior years. The best approach to this is as follows:

  1. Start with considering what has changed compared to last year
  2. Ask relevant people, key employees and customers for their input and thoughts
  3. At its simplest, take sales for the current financial year and add/subtract a percentage
  4. For more detail, budget sales for individual business lines, locations, customers
  5. If you’re selling time, take the number of people x % utilisation x days worked
  6. If you have several service lines or products with different profit margins, budget each separately. This is essential if the mix of what you sell is changing
  7. Factor in seasonality. Look at month by month sales trends for last three years and calculate what % each month’s sales contributed to the annual total. Apply that % to the annual sales figure you want to achieve to get the month by month sales budget for each month.
  8. The more detail you have, the better you can assess actual performance, especially if some areas of the business are growing faster than others.

If you have a business with “lumpy sales”, ie relatively few sales of large value, it may be difficult to predict exactly when the sales will fall. The above advice still applies. Although you will smooth out the likely peaks and troughs, the budgeting process will help you manage your business better.

Budgeting Direct Costs

Direct costs are the costs that vary directly with sales volumes. Some general guidelines here:

  1. The past is normally the best guide to the future, all other factors being equal
  2. Calculate each direct cost as a percentage of the sales revenue total
  3. If the gross profit % is different, break direct costs down for individual service lines/products
  4. Factor in known or likely changes that might affect the gross profit %

Budgeting overheads

Overheads should be the most accurate figure in any budget as the majority of the next year’s costs will be similar to those in the current year. Factor in any important changes, such as rising headcount or moving premises and work out the financial effect.

You will always be wrong!

The one thing you know about any budget is that it will be wrong ….. but hopefully not too wrong. But that’s not a reason not to put one together. If you know what you’re aiming at, the greater the chance that your plan will succeed. You will have thought about what you need to do to create that success.

Don’t forget the cash

Finally, remember that you cannot put together a profit and loss budget or forecast without giving consideration to the cash implications. Budgeting is not a stand-alone process.

Do you need a capital injection? Is more working capital finance required? Can you manage the business better to generate cash quicker? These are the questions you should be asking and answering to ensure cash is available before you actually need it.

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