It’s that time of year again…………Budgets, the bane of my life!
As we approach the end of June businesses should have completed the final stages of their budgets for the 2018 financial year. I have completed hundreds of budgets over many years, some of which have been absolute master pieces (If I don’t mind saying so myself) and some not worth the paper they were printed on. I have also had many discussions, debates and even arguments over the benefits of budgets.
Nearly every client we have worked with has not had a “proper” budgeting process in place when we first meet and nearly every time the business owner will say “it is too hard to budget for my business, it is too complex and our market is changing so quickly”. This is when we start to debate!
Firstly, what do I mean by a “proper” budgeting process?
- Prepare the budget on a monthly basis based on your normal trading cycles i.e. allowing for seasonality and timing of expenses and not just dividing an annual budget by 12.
- For small/micro businesses (say with revenue less than $1 million) a detailed ‘profit and loss’ budget should suffice i.e. a budget for every income stream and expense item in your profit and loss.
- For every other business, a detailed Profit and Loss, Balance Sheet and Cash Flow budget should be prepared for the financial year on a monthly basis.
- This budget should be prepared with detailed assumptions based on what we know now about the business, the market and the economy.
- Once finalised and approved, the actual operating results should be compared to the budget each month and any significant variances explained thoroughly.
One of the criticism of budgeting is that it is prepared based on ‘educated guesses’ of what is going to occur in the future, however, this is better than managing your business on pure ‘gut feel’.
Surely, it is better to see a detailed budget as outlined above based on ‘educated guesses’ rather than having nothing at all. If the business or market fundamentally changes during the financial year we can re-cut the budget (‘re-forecast’) to allow for these fundamental changes.
Revenue is always the most difficult and the most important item to budget for. Some just budget based on last year’s revenue plus a percentage increase i.e. 10%, this is just a ‘cop out’ and often a waste of time. My tips for budgeting Revenue are:
- Budget for Revenue and Gross Profit at the same time as the future trends may not be in sync i.e. Revenue may be increasing but margins are being squeezed in a more competitive market.
- Review the last two financial years’ data to identify any seasonality, peaks, troughs or trends in Revenue and Gross Profit.
- Meet with key sales staff to get what their view is of the future. Are they expecting significant improvements in revenue and/or margins, or a declining or stagnant market?
- Document what issues you believe will affect the Revenue, and ultimately the profitability, of the business over the period being budgeted.
- Document what the strategy for Revenue and margin growth/management is over the same timeframe
- If possible, budget for Revenue (and Gross Profit) in as much detail as possible e.g. by profit centre, by product/service, by customer, by project, by contract, by geographical location or even by asset or salesperson. The greater the detail the easier the business performance will be to monitor.
Once the Revenue and Gross Profit have been budgeted for the rest of the budget should be reasonably straight forward to complete. However, I would strongly suggest you engage your accountant or corporate advisers to assist with the preparation of the budget as it can be a time consuming, detailed process.
The key to successful budgeting is to use it as a dynamic management tool in your business and to make sure it is closely aligned to your strategy. We have had clients who have predicted their revenue will grow 20% in a stagnant market without being able to articulate what their strategy is to achieve this. If they can’t articulate their strategy, they aren’t going to achieve 20% growth!
If done “properly” an annual budget, which is aligned to the business strategy, can be a fantastic tool to use to manage and monitor any business, and I strongly recommend that all businesses complete a budget at least annually.
About the Author
Tim has vast experience in the strategic and financial management of businesses with a particular focus on cash flow and profit improvement, strategic thinking and performance reporting. He has extensive knowledge of business start-ups and acquisitions as well as exit and succession planning. Tim is an adviser with Supertrac, a corporate advisory firm specialising in business divestments, mergers and acquisitions.
Tim is a Fellow of the Institute of Chartered Accountants (FCA), Graduate of the Australian Institute of Company Directors (GAICD) and a Certified Exit Planning Advisor (CEPA) with the Exit Planning Institute (EPI).
If you have any specific questions or would like to suggest future blog topics, please do not hesitate to contact Tim on firstname.lastname@example.org.
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