Budgets are the roadmaps for your business’ future. With clear departmental and company-wide budgets in place, everyone on the team knows the goals you are trying to reach and the parameters they have to work within. They can measure their success or failure relative to the standard at any given time, adjusting throughout the year as needed in order to ensure business goals are met or exceeded.
Creating a budget doesn’t have to be a daunting task. In fact, it can be pretty simple, but more importantly, it can be an eye-opening experience. You can learn more about your business and what you can do to reach your goals by walking through the budgeting process.
You can create all the budgets you want, but if no one is paying attention to them, or if they are created in a vacuum, it’s wasted effort. Before delivering budgetary guidelines, you must first identify and communicate your goals. Here’s the thing, though, they need to be realistic and based on a number of factors.
Here are three tips to help you get started, followed by a brief guide to constructing a solid budget that works for your business:
1. Look at Your Growth History
Has your company grown at a steady 5% pace over the years, or does your growth chart look more like a mountain range filled with lots of dips and peaks over time? Can you determine why your business has grown the way it has historically? And will these factors continue in the coming year?
You can glean a lot about the future by looking at the past. Review your historical growth so that you know the goals you set for the upcoming year are realistic—maybe even a bit aggressive.
2. Look for Industry Trends
No business lives in a vacuum, and we are all affected by what is going on in the world at large. So it pays to look at what is happening in your industry, as well as those industries that you serve.
Many trade organizations will publish industry data that allows you to compare your business to others. For example, in the hospitality industry, sites like STRGlobal.com allow hotels to participate in and receive a benchmark report that details overall performance figures for hotels in their market.
3. Look for Help From Your Employees
For those small businesses that have employees, it’s never a bad idea to ask for feedback and help from your team.
First of all, they may know of industry trends or upcoming expenses that you may not be aware of. Second, and more importantly, they will be more engaged and take ownership in keeping up with the budget if they are involved in the process from the beginning.
While you may have a better view of the company’s big picture, your employees can often provide input on the day-to-day issues that can greatly impact a budget. By working together, you are more likely to identify realistic goals for the company, around which you can build a budget that makes the most sense, which brings us to our next point.
How Do You Build a Budget?
Now that you’ve reviewed your company history, looked at industry trends and consulted with your employees, you should be able to set some realistic goals for the upcoming year. So how do you use that information to create the budget you need? Let’s find out.
1. Start With What You Want at the End of the Day (Cash)
We can have all the goals we want, but if we don’t have the cash to pay ourselves and support our families, those goals are moot. Make sure you know how much cash you need each month to operate, so you can carve that out first before you spend any money on items that are not absolutely necessary to day-to-day operations.
2. List Your Projected Expenses, Starting With Fixed Ones
If you’ve been in business for any period of time, you should have a good idea of what your fixed expenses will be for the upcoming year. Fixed expenses are those that do not change with fluctuations in revenue, sales or production. These include things like rent, insurance, dues and, depending on your industry, salaries.
3. Now List Your Expected Variable Expenses
Unlike fixed costs, variable expenses can increase or decrease based on the activity of your business. For example, expenses for a manufacturing company would have to account for higher costs of raw materials as the company’s production levels rise. On the other hand, for a professional services firm, it could involve higher payroll expenses if you have higher revenue and need to expand your team (more work, more people to do it).
Based on the goals you have set, the company’s past patterns and the trends in the industry, what variable expenses do you anticipate your company will encounter in the coming year?
When that’s figured out, determine what percentage of revenue your variable expenses are. You can do this by dividing the variable expenses from a 12-month period by the overall revenue from the same period. Keep this figure handy, as you’ll need this percentage later.
4. Build in Your Projected Revenue
Once you’ve identified and listed all of your anticipated expenses, it’s time to talk about how much money you expect to bring in to the company. When you were identifying your goals earlier, you probably thought about how you were going to meet them, so here’s where the proverbial rubber hits the road.
How much revenue do you expect to bring in each month and for the year? If possible, break it down by department or product line, so you can get a truly realistic picture of where your revenue will come from for the year.
Plug these numbers into your budget. Here is the basic format you should use:
Projected Revenue – Variable Expenses – Fixed Expenses = Projected Net Income
Now for the moment of truth: Does your projected net income equal how much cash you need at the end of the day? If not, what can be done to fix that? Are there additional ways to decrease your variable expenses or increase your revenue that you haven’t tried yet?
Often the budgeting process can uncover amazing opportunities or issues that need to be addressed. Don’t allow yourself to be alarmed or overwhelmed. You’re revealing valuable information that will help you make informed decisions and ensure that your company is as financially strong as it can be.
5. Remember to Make It Stick!
To get the most from your budget, you must be sure to use it. Don’t just create it and shove it in a drawer. Stick with it and update it as needed throughout the year. While you spent time anticipating the upcoming year’s influence on your budget, no one has a crystal ball. Updates are necessary and expected from time to time. Review where you actually are compared to your projections, and make changes as needed.
A simple budget versus actual report can be generated in most accounting systems. The fact that you have a plan to use for comparison and measurement is a powerful advantage. You’ll be amazed by the insight and control that this information will provide, and how it allows you to make better decisions and adjust to change as it occurs.