Whether you are a new small business owner or have been running one for a couple of years, you probably have encountered financial challenges that leave you wondering how to allocate your resources effectively. These challenges will continue to grow as you scale up your business. In today’s economy, filled with uncertainty, increasing competition, and unstable revenues, many companies are overspending when their expenses should be lean, leaving them unable to capitalize on investment opportunities to grow their business.
This budget-planning guide for business will help you understand how to transform the way you plan your business budget, which is critical to surviving in today’s economy.
Understanding budget-planning basics
What is a budget? To put it simply, it is a plan for your revenue, expenses, and profit. Effective budget planning helps your business to become well-prepared for the landscape we live in today, where revenues come in chunks instead of a steady stream and where expenses can suddenly skyrocket due to unforeseen situations.
Knowing how to plan for your business budget starts with knowing when to begin. Ideally, the business budget should be created on an annual basis for the upcoming year. The budget will act as your road map on how much money is needed to run your business and most importantly, shines a light on the areas that need attention. It tells you whether you are spending too much or if cash flow is becoming tighter due to a drop in revenue.
Let’s not confuse budget planning with cash-flow planning. A budget report details the current financial performance of a business, while cash-flow planning details the inflows and outflows of money through a company. Budget planning allows you to identify revenue sources and expenses in a way that enables you to make executive decisions that optimize operations and your bottom-line profit.
Creating your budget plan
A robust budget plan begins with identifying the essential components of a budget and following these steps:
- Tally your income sources. These include all revenue sources your business is receiving: sales volumes, hourly earnings, and investment outcomes. The more sources you can segment out with clarity, the better, as this will aid in identifying which income source needs more attention.
- Draw up your revenue projection. Projecting your sales for the upcoming year should be done as accurately as possible with a conservative bias if you are unsure about business in the year ahead. A good basis to benchmark your revenue projection against is last year’s actual sales figures and growth. If you’re starting a new enterprise, then conducting research of competitors’ growth is a good step to take.
- Consolidate your costs and expenses. This step determines how much it will cost your business to clinch those sales. To simplify this section, your business costs and expenses can be divided into fixed expenses, variable expenses, and one-time spends.
Examples of fixed expenses are rent, utilities, employee salaries, and administrative costs. These costs remain generally the same regardless if business is rising or falling. Variable expenses represent expenditures covering advertising, transportation, marketing costs, and renovation. These costs are correlated with the volume of sales your business experiences. One-time spends include your office furniture and computer hardware.
With these components down, you are one step closer to transforming your enterprise into a business with effective budget planning. Next would be to bring this information together and set key performance indicators (KPIs) for the year ahead.
Three KPIs every business should set and monitor are:
- Target sales revenue. This target will be the main driver of decisions concerning your business expenses and costs. If your business has been running for a few years, take into consideration scenarios that include the loss of a major client or a downturn in the economy and how that will affect your revenue. If your business is new, estimate the revenue you can realistically attain.
- Operation expenses. If you are established, now is the time to pore over those financial statements, which should include a list of fixed and variable expenses incurred over the year. If your business is a startup, it’s important to think through and factor in all the costs you believe will be essential to keep it running.
- Gross profit margin. Look through your historical profit margins if you are established; if not, then estimate the costs of your goods sold and subtract them from your sales revenue.
Remember: Using realistic figures is key to attaining a budget that is as accurate as possible. Your budget can be easily tweaked to adjust any estimates for better financial decisions, from figuring out which expenses can be cut in case of a downturn to determining if hiring new employees is financially wise.
Improving your budget-planning processes
While budgeting has become an integral part of business accounting, some common problems still arise. One of them is setting overambitious goals. Aggressive projections will not only hurt the decision-making based on your budget report, but also affect employee morale when facing a target that might be impossible to achieve.
Another important problem that might arise is the budget’s link to employee compensation. Sales representatives looking to hit their targets might be tempted to shift sales from a period where revenue is high to a slower-performing period. This will skew the end result of the budget report and end up in wrong decisions being made.
To make budgeting more efficient for your business, keep these tips in mind:
- Equip your team with a calendar of submissions and ownership guide. This will go a long way toward personal accountability. Using one standardized budget model and one set of templates will also help streamline and simplify the process.
- Decide on using either a bottom-up or top-down budget target-setting model. A bottom-up approach that starts with projections for each specific product is simpler, but might produce errors that accumulate as the numbers are totaled up. A top-down approach might be more accurate overall, but could result in unrealistic numbers at the level of individual departments and products.
- Use automated tools and systems for planning and forecasting. Keep in mind, though, that you need to understand the purpose of forecasting and scenario-based techniques to effectively get the most out of these tools.
There are still businesses that run on outdated solutions. Some organizations still use Microsoft Excel since it’s practical and readily available.
A business serious about budgeting should transition away from Excel and move towards enterprise resource planning (ERP) and budgeting software. By using such automated professional tools, you will:
- Save valuable time with a fast learning curve without any prior accounting knowledge needed
- Consistently stay organized with invoices and payments once the basic framework is set up, without needing a whole department to handle each component
- Make your budgeting accurate with streamlined data entry to cut down on redundant double entries that might contribute to errors
- Have access to key financial data at your fingertips. This access to real-time data will give you insights into the performance and health of your business
- Help make audits faster and more accurate, as well as prevent and reduce any costly penalties from red flags
Selecting the budget tools and solutions you need
Before you adopt new technologies to add value to your budget planning, here are some key questions to ask:
- How should our budgeting, planning, and forecasting process change to maximize the tools available?
- How can we improve the return on all expenditures?
- How can our real-time data and predictive analytics help us gain better insights?
- Which customers provide our current profitability, and how that might change in the future?
Once you know the answers to these questions, you’re ready to start investigating options for budgeting software.
Your software should have the essentials, such as applications for general ledger, journal entries, project cost accounting, budget management, financial reports and analysis, budget and planning forecasting, multi-currency support, automated revenue stream from invoices, as well as a KPI dashboard.
Strong and robust budgeting software must be centralized, flexible, and secure, and it should be coupled with a powerful calculation engine.
Choosing a cloud-based solution will give you several key advantages that include faster deployment, reduced reliance on IT, reduced upfront hardware or software cost without the need to install, maintain, or upgrade over time, and most importantly, better security. Conducting your business budget planning with a cloud solution is, indeed, a smart step to take.
Budgeting for your business doesn’t have to be complex. It’s just a matter of following a time-tested process of creating a budget plan from your revenue and expenses, understanding the different approaches to model after, and selecting powerful budget software that gives you the necessary tools to succeed.
Find out how you can improve your budgeting with SAP Business One, which consolidates all the key financial components required to run a high-performing business.
This blog originally published on the Digitalist Magazine.