Most business owners view a budget with utter disdain. They’ll use any excuse to not prepare a budget. Some of the excuses I have heard over my career:
“Who has time for that?”
“Our annual earnings don’t really change from year to year.”
“Sales are flat, why bother?”
Most business owners run their business based on the business’ history and the owner’s experience. Sometimes this works well, other times not so much. Remember the credit crisis of 2008? Our business clients who weathered the storm were the ones who had transparency into their business via a budget. They could model the effect it would have on their profitability and cash flow using their existing budget and adjusting their expenses or payroll accordingly.
So, why prepare a budget? As previously discussed, transparency into the effects business conditions have on cash flow and profitability. Another reason is to plan for growth, organic or merger. Growth creates its own challenges such as the need for financing. A merger needs to be modeled to attract possible financing. Yet another reason to create a budget is to see how pricing changes affect profitability.
What is a budget?
A budget is simply your estimated income and expenses for your business year, a pro forma document, meaning you’re using your knowledge to estimate the how you will see the year. A budget typically reflects how your company expects to spend money in the future.
Let me say it again, it is your spend, meaning you have built into the budget hiring for growth, a new or larger facility, etc. It will change as you move through the year and must be updated. I like to update each month of the budget with actual results, so trends can be spotted and profit and cash flow projections more accurate with the known adjustments. This is especially useful when communicating with a bank or investors.
How do I prepare one?
Depending on the size of the business the budget process can begin as early as August or September. If your business has a sales team, it is imperative you start with them. Have each sales person develop their sales budget by month and by customer. Do not just accept the numbers provided challenge them based on your expectation of reality, against their previous sales and the current economic environment. This will form the foundation of the entire budget.
Next, review your historical gross margin, listen to your sales team as to pricing pressures and project the gross margin. Finally, estimate your general and administrative expenses such as administrative salaries (accounting, HR, executives) insurance, utilities, rent, travel and entertainment.
Here again, you’ll reference history and change in operations and possible hiring patterns to estimate the expenses by month. This becomes your plan for the year and if sales are not being obtained, or margin is lower than obtained, then changes will need to be made in personnel or expenses.
Of course, if you are satisfied with the ultimate operating margin, maybe nothing needs to be changed. The important thing to remember is this will hold your employees accountable to the plan, if you hold yourself accountable to developing, monitoring and taking action against it.
Where to start? Your accountant is a great place. Don’t have one? Fix that now and call Magone & Company at (973) 301-2300.