Some business owners choose not to set a budget, using excuses like:
- it’s onerous to do
- it’s complicated
- it’s out of date after a month.
The reality is quite different. Think of a budget as a guiding light for where your business is going to go within a specified period. Setting a budget:
- doesn’t need to be hard
- is an essential business tool
- provides a basis for a cash flow forecast
- lets you do ‘what if’ scenario planning, which can help you make decisions
- gives you peace of mind.
Why should a budget be detailed?
Let’s say you’re setting a budget for a year. Usually, a business plan would tell you where you want to go and how you’re going to get there. And then you use the budget to put some numbers around the business plan for a 12-month period. So, the budget is there to help you bring the business plan to life.
But your numbers have to be viable. You can’t just say, ‘Oh yeah, I’ve got a budget. My budget is $2 million in sales, 80% gross profit, and 25% profit before tax.’ It doesn’t work that way – because they’re just numbers on a page. There’s nothing that substantiates them, nothing that validates that the percentages are actually correct.
So, how do you make them viable? You break them down into smaller chunks.
How to budget
What does $2 million over 12 months look like per month? If you have enough history from prior trading, you could establish the likely monthly trends the business might mirror in the sales goal. Or, if you have enough knowledge of the sales trends you are capable of generating across the next 12 months, you can establish the monthly sales goals.
Having that sales number broken down by month means that you can then determine:
- what materials, products and staffing resources you need to ensure that you can make those sales figures
- how you will get those resources
- the cost of those resources per month, which means you can now know your gross margin by month
- whether the 80% you wrote down on that piece of paper earlier is actually valid.
Once you have your sales broken down by month and your cost of sales broken down by month, you can concentrate on budgeting the costs of running your business, which is generally referred to as your overheads. These include paying for things like:
Overheads can be fixed or variable. Your rent, for example, is fixed. Your electricity costs fluctuate slightly but are pretty fixed depending on the season. Once you budget for fixed overheads, you can then budget for variable items like marketing, client gifts, entertainment, team away days, and so on.
Pulling all those figures together means then that you can now work out:
- sales by month
- cost of sales by month
- cost of running your business by month
- profit by month.
Now that you know exactly what you have available, you can put plans in place to make the sales happen and manage your costs in line with how you budgeted them.
Keeping your budget current is not a problem either. If something changes three months into the year, you can simply refresh it to reflect current trading so that the forecast for the remainder of the year is still valid.
Benefits of budgeting
Making the effort to set a detailed budget will pay off in more ways than one. Your budget will tell you:
- what your cash requirements will be, giving you a basis for a pretty accurate cash flow forecast
- whether or not you are going to make any profit
- whether or not you’re going to be able to afford to give your staff pay rises this year
- whether or not you’re going to be able to give yourself a pay rise this year
- whether or not you are going to be able to replace the vehicles this year.
A budget also gives you a basis for ‘what if’ scenarios. What if I lost my biggest client and $40k was gone straight away? Could I handle it, or would I need to make redundancies? What if my sales dropped by 10%? Would I need to change the way my business operates? Being able to think through scenarios like these often gives business owners peace of mind.
If you need advice on setting a budget for your business, contact us.