Despite this, many businesses either do not do any budgeting or do this in an informal, reactive way which doesn’t always support the goals they are trying to achieve.
While all businesses should have a budget which supports their strategy and goals, it is particularly important for growing small businesses who have limited resources and need to be specific and intentional about exactly where their money is going.
In this article I will share with you my insights into creating a reliable financial budget and how to put this to good use.
It all starts with a plan
Budgets are most useful when they are integrated with an organisation’s strategy so, ideally, the development of a budget should begin with the organisation’s strategic purpose.
Operational plans are downstream of strategy and the structure of your budget will reflect what is required to implement these plans so it therefore makes sense that understanding your strategy will be the first step in the budgeting process.
Furthermore, by setting benchmarks for how an organisation is going to achieve its goals over the short term, budgets are useful tools to gauge if an organisation is on target in meeting its operational plan and hence its strategic plan.
Budgets can then be a signal to managers on whether they need to revise their plans and possibly even the organisation’s strategy.
Cash is King
Having a profitable business model means nothing if the management of your cashflow is neglected or poorly implemented. It is for this reason that I believe the cash budget is the most important financial budget.
When done right a cash budget can help you to anticipate when there will be cash shortages or any surpluses. This will enable you to make forward plans such as when to borrow or spend money (e.g., buying assets, repaying loans or even making short-term investments).
This knowledge can also feedback into your decision making and may highlight a change that is needed in your operational plans or policy.
For example, a profitable business that is projecting a cash deficiency may discover they need to review the credit terms they provide to customers or their policy for managing inventory.
Don’t be afraid to flex
One of the difficulties in the traditional approach of establishing an annual budget is that it will lose relevance if your trading environment or plans change dramatically.
Therefore, it is often useful to take a more flexible approach by having either a moving 12-month or quarterly budget or to use a combination of both.
The purpose of a rolling budget is to allow managers to plan a full year ahead constantly, and not only once a year when budgets are prepared. Constant future planning is important to all organisations, but more so when organisations operate in rapidly changing environments.
Variance analysis
Since they set standards and benchmarks, it is best practice to use budgets to monitor and to control the use of resources and evaluate performance.
This is done by frequent and timely (usually monthly) comparison of actual results with budgeted forecasts—referred to as variance analysis. Ideally your budget targets are realistic but challenging. The purpose of variance analyses is to understand the differences between these targets and actual performance.
Once these are known, the causes of the differences can be investigated, and action taken accordingly. Variances can be an early indicator on the performance of your strategy, can identify emerging trends in the business and can help to establish if and where changes need to be made.
More than just a projection of your performance a well-defined budget is a blueprint for executing your strategy and underlying operational plans.
They also provide a marker for success as they help you to define what this looks like for your business.
The important things to remember is that your budget should be built on the foundations or your business strategy or plan, should be realistic but challenging and should be flexible to allow you accommodate for unexpected changes in your business and the environment you are operating in.
Joseph Essey is the founder and operator of Your Business Finance Manager, an Outsourced Finance and Accounts solution for growing small businesses and has over 15 years’ experience helping small to medium sized businesses to manage their financial position and achieve sustainable growth. Visit: www.ybfmanager.com
