Why is this important?

Having an accurate and realistic budget is critical to your business’s continued success.
An important component of your business plan is your plan for your financial position.

The adage “Failing to plan is like planning to fail” reinforces the fact that unless you know where you are going in the business, you won’t know when, and if, you get there. This not only applies to the vision you have for the business but also how you plan to get there financially.

A carefully considered budget provides a guideline for expected income and expenses and enables you to compare your anticipated financial goals with the actual numbers. It acts as a barometer for the way your business is tracking against expectations, making it easier to predict profits. It forces you to think through all the important numbers and to develop a picture of what your business is going to look like in three, six, nine and 12 months. It enables you to plan ahead, make appropriate spending decisions and determine any changes that should be considered in your business plan.

An accurate and regularly reviewed budget enables you to make better use of capital, address issues sooner rather than later, and run a more efficient business operation.
A budget won’t necessarily solve your business’s financial difficulties but it will serve as an early warning device.  

The budget advantage

Growing any business is dependent on strategic planning, and a critical component of this planning is having knowledge of future income and expenditure.

An accurate and realistic budget, and one which is reviewed regularly, enables you to:

• determine a break-even number, therefore providing a target to aim for each month
• compare against actual performance and quickly identify losses and take remedial action
• review expenditure regularly and make informed decisions
• plan future operations more effectively
• provide factual information required by your financial supporters (shareholders and banks)

When you develop your business plan it is recommended that you prepare three plans to face all possible scenarios - best case, worst case, and most likely case.

Keep these documents close to hand at all times, and make necessary changes to both the plan and your budget as the year unfolds.

You may need to be flexible with your plans and the budgets that underpin them. The business environment can change rapidly, and in extreme ways, and you need to be flexible and be prepared to amend your plans and change your strategy to respond to the changes.

What to do

Some important considerations

1. Determine realistic sales projections

The key areas to budget for essentially relate to the Profit and Loss Statement. Sales turnover is the starting point and is one of the most important numbers in the whole budget. There are two key questions which relate to this:

• What will our sales be?
• What do we have to do to achieve them?

This then impacts on business strategy.  The business must design and implement strategies to achieve the sales which have been budgeted for.

This highlights the point that preparing the budget cannot be done in isolation from other business activities, and in fact, the budget is a fundamental component of the overall business operation.

2. Determine direct costs

These are the costs associated with sales – ie the costs of materials, components or subcontractors to make the product or supply the service.

3. Determine fixed costs or overheads

Break these down by type, eg:

• cost of premises, including rent or mortgage, business rates and service charges. Rent is usually fixed and often there is an allowance for inflation. Consideration should be given to whether you need, or will need in the near future, all the space you currently have.
• staff costs. List your staff and note down your expectations for their salaries and wages, including benefits, insurance etc. over the next year.
• utilities – eg heating, lighting, telephone etc.
• printing, postage and stationery
• vehicle expenses
• equipment costs
• advertising and promotion
• travel and subsistence expenses
• legal and professional costs, including insurance

4. Don’t forget variable costs

These are the anticipated expenses that can fluctuate from month to month, like office supplies, utilities, marketing expenses, and professional development. A good tip for gauging these types of expenses is to go back over your previous 12 month’s records, total this type of expenses, add a buffer for price rises, and divide the total by 12. This should give you an approximation of these expenses spread out over a year's period.

5. Purchases

What do you expect to spend on purchases? Last year’s figures will be a guide, but it is more important to understand your suppliers, and their expectations. Do you have a relationship with them? Can you have one? What purchasing discounts can you obtain? What do you need to do to obtain them?

6. Budget leads to cash

Your budget is your expectation of income and expenses for the year ahead. It is important to drop this information into a monthly cash flow forecast which shows when the money actually comes in and when it physically has to be spent.

If you are in retail, or if you make cash sales, you collect the cash when the sale is made.

If you are accruals based (ie. you give your client an invoice when you make the sale, or raise a fee, or perform a service) this is also treated as a sale, and counted as income, even though you have not received the cash. The accrual method also applies to expenses. If you get an invoice from a supplier this is regarded as an expense, even though you haven’t actually paid the cash.

Your budget is prepared on the accrual basis and your cash flow is prepared on the cash basis. The trick is to get these two to talk to each other. By knowing how long it takes to collect your cash after you raise the invoice, and when you have to physically pay your expenses, is what ties your budget into your cash flow.

Your business needs both tools, the budget and the cash flow, to provide the full picture of your finances.

7. Budget for Income

There are a number of different methods for estimating your cash. The most common method is to review last year sales and use it as a guide. Simply adding a percentage to that figure and using it as the budget, though common, is hardly very scientific and requires no analysis. A more detailed consideration should be given to the process. It should be possible to do an analysis of the sales made to your customers. Review this as a starting point. Consider each customer, and identify a sales target for each of them, or at least for the larger ones.

Work your way through the list, and this will give you a solid base for your estimate. It may also prompt some strategic decisions around your customer relationship program:
is there more you can do with your existing customers that may encourage them to buy more?

Identify any customers who went quiet last year, but were active the year before and organise for them to be contacted or visited to find out why there was a drop in activity.
Analyse your customers according to the Pareto Principle’s 80/20 Rule, which states that 80% of your sales come from 20% of your customers.

You might also cross check your budget against product sales, or income from various service lines. Your business may have many customers and it may be difficult to determine budgets per customers, but it might be possible to estimate it according to service lines. This is also a useful method if:

• you are planning to launch a new product or service, or
• you want to tie the budget to your marketing plan and activity.

8. Budget for Expenses

Expenses tend to be the easiest figures to budget for. Many of these items are fixed or recurring, such as rent, motor vehicle leases, and hire purchase payments.

When you are setting the budget it is useful to review and challenge all costs, rather than simply taking up the expenses that were incurred last year. Look at each component of your product costs. What can be purchased more efficiently? What savings can be made? What can be reduced without reducing quality?

Next look at each component of the production process. What can be done more efficiently? Where can you find productivity improvements? Get team members involved in the process and they will become aware of the key areas of expense in the business, and will take an ownership in the result.

9. Budget for Debt Repayment

Whenever possible take an aggressive debt repayment strategy to reduce your exposure and reduce your borrowing risk; and factor these extra payments into your cash flow forecast. Less debt also means you are in a better position to take advantage of opportunities as they arise in the market.

10.         Budget for Capital Expenditure

Capital expenditure should also be budgeted for. This may be linked in to your debt repayment program, whereby, as the debt reduces, you are also considering the timing of any capital expenditure required.

A lower interest rate environment may make a compelling reason to consider capital development. This should be couched in terms of certainty of income required to meet the repayments on any borrowings undertaken. That is, a costs/benefits analysis should be undertaken before undertaking any substantial new capital projects.

If capital expenditure is to be financed, these additional payments need to be factored into the cash flow forecast.

A slower business climate may represent the perfect opportunity to put in place a deliberate plan for repairs and maintenance. Maintenance adds to the longevity of property, plant and equipment and therefore extends the investment made in these assets. This improves the return on investment, one of your key objectives as a business owner.

11. Budget for Tax

The Tax Office is one creditor you can’t ignore. Your taxation liabilities will never go away but in effect, with interest being charged on unpaid balances, they will continue to increase.

The Tax Office has strong powers of recovery, with the power to make directors personally liable for company debts in certain circumstances.

Most businesses make instalments towards their annual tax liability and these need to be factored into your cash flow forecast calculations.

It is possible for your business to vary the amount you pay for your tax installments. However, penalties apply for inappropriate variations, so it is recommended that you use extreme caution, and talk to your accountant.

12. Budget for Cash

In any business Cash is King. All items which have been budgeted for, both income and expenses, must be reviewed for their impact on cash. It is not just the size of the expense, but the timing of when the money comes in and when the money goes out, that is important.

Understanding your debtor days - the average amount of time it takes your debtors to pay their bills owing to you - is vital to understanding cash inflows. Most software programs automatically calculate this for you. It is very important for cash planning because you need to know the average amount of time it takes your clients to pay you after you have issued your invoice.

Once you know your average debtor days, you can plan for this on your cash flow forecast.

The budget process has identified how much you expect to achieve in sales for each month of the year. The cash flow forecast then plots the timing of the cash received when the invoice is paid.

The importance of this step cannot be overstated. By plotting when you expect to receive the cash, you can compare this against your expectations for when expenses must be paid.

This will give you a clear picture of what your cash position will look like in the months ahead. It allows you to plan now for any shortfall or deficits that you see looming on the horizon, and lets you put plans in place to deal with it before it happens.

This is one of the most important benefits of budgets and cash flow planning. It lets you plan in advance for any tight financial situation which may occur and lets you put in place alternative funding arrangements if you can see difficult times ahead.

13. Review your budget  

Budgets should be reviewed monthly if you want to quickly identify overspending and potentially loss making situations.

Work through every line of the profit and loss report, and consider:

• Is there a better way of achieving this outcome?
• Is there a more cost-effective way of doing this?

Where to go for help

Do it yourself

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