Are you managing a business or a hobby? Only one thing differentiates the two; it is the ability to generate and maintain profit. Business is as simple as 1-2-3.
- COST – Know your cost of goods and operating expenses.
- SELLING PRICE – Know your price point in the market.
- PROFIT – Know your profit.
However, the 1-2-3 of business often becomes secondary to the entrepreneurial passion or living the dream of being self-employed. Unless the business owner has a solid financial and business background, they will focus on making money instead of managing money. Financial literacy deficiency is what small business owners are primarily suffering from today. Most small business owners rely on their accountants and bookkeepers to look after their financial affairs instead of applying themselves to mastering the art of accounting. Yet the backbone of any business comes down to the B-word, Budget! Budgeting can be as straightforward or as complex as you want it to be. At the core of a budget is financial planning so you can better manage revenue, expenses, profit, and cash flow!
The primary purpose is to plan for cash flow in the coming financial year to give your business the best chance to stay on top of planned, fixed, and unplanned expenses. So, where do we start? Good financial planning will consider all projected income and expected costs for the next 12 months to give the business a reasonable estimate of projected profit accumulation throughout the year.
However, budget flexibility is essential. A budget will evolve throughout the financial year, depending on various external and internal market influences. Covid-19 was probably the most prominent example of a budget crisis. When Covid-19 hit most businesses, the first reaction was to go back into the budgets and adjust the forecast to reflect the new economic situation. A simple exercise like this will immediately expose what expenses must stay or go for the business’s survival. When completed in advance, a business budget allows complete transparency and understanding of its profitability and financial health. The budget versus actual analysis becomes the pulse of the organisation and brings peace of mind to the owners.
Here is an example of what a budget will typically look like for a small business.
Operating budget-focused expenses
Unfortunately, the central part of most budget planning focuses on expenses, while revenue seems to be just a one-liner on the page, two if you are lucky. Hence the reason why most business owners do not like doing a budget. If you focus on expenses, you are not in the right mindset to grow your business. Business owners who focus on income and the bigger picture are why they win new business.
Acquiring new clients is the easy part but managing the growth of an organisation is more challenging. Business owners will often be apprehensive about scaling because of a lack of understanding of the financial impact of managing operating and marketing expenses. You can only control what you can measure. Bookkeepers will tell their clients to break down all costs into accurate and relevant expense groups to reflect spending patterns and better understand where the cash is going. Once business owners understand what percentage each expense group is of their overall revenue, they start spending more conservatively. Insight and foresight are paramount when it comes to financial planning.
An expense-focused budget is what companies do when they suddenly lose revenue and adapt quickly to a crisis. A business owner with a detailed expense budget will be able to take calculated risks to invest in specific business areas or take decisive actions to reduce costs in the areas that are not delivering properly. The latest online accounting software, such as Xero, enables easy budgeting solutions nowadays, which is a great way to streamline your accounting activities and always keep a close eye on the numbers with monthly automated management reports.
Budgeting for scale is different from an operating budget. When a business is looking for growth, it will create an investment budget to drive new sales and market penetration initiatives based on sales forecast. A growth-focused budget is effectively a business case, where the projected return of investment is forecasted over a period to justify new investments.
Depending on the structure of the business, growth budgeting can become complex. A growth budget will have specific investment sections such as branding costs, additional resources costs, capital investment and EBITA (Earnings Before Interest, Taxes, Depreciation, and Amortisation), to name a few. A growth budget is a top-driven budget where the sales forecast will dictate operating expenses. These are the types of budgets that excite entrepreneurs as they become vision boards for the organisation.
Let’s say, for example, a chiropractic business is doing well, and the practice is running at total capacity most days. The business manager sees an opportunity for growth and wants to explore the possibility of expanding. Additional investment required for the new lease, refurbishment, marketing, and new resources to enable the scale becomes part of the existing budget as an investment against a new forecast in sales over time.
This simple budgeting exercise for growth effectively plans and sets up a pre-condition for scaling up the business. An investment budget will give a clear projection of how quickly the business can recover the investment cost and generate additional revenue to scale, giving more confidence to the owners and investors.
Plan it before you do it
We all know that if you fail to plan, you plan to fail! Most small business owners realise the importance of a budget the hard way when they get overwhelmed with unplanned tax bills, unnecessary business vehicles expenses, or over-resourced payments that come back to bite them. Unaccounted costs in a budget can quickly snowball and choke a business.
Although the focus should always remain on sales and revenue, budgeting for most business expenditures is the only way for an organisation to maximise its profit and thrive. Whether it be on a whiteboard or a spreadsheet, the mere act of budgeting brings more clarity and confidence for business owners to make better financial decisions for the future. Every month when the actuals versus budget come through shows whether the company follows the original roadmap or requires adjustments to maximise profit.