As the old saying goes: “He who fails to plan, plans to fail”. Financial planning is an important ingredient for success for any small business. Remember, Cash is KING, and the last thing you want to do is to suddenly run out of cash in your business or to wastefully spend your cash when you seem to have an excess.
A good rule of thumb is to have your eye on your cash flow all the time and to be able to predict your cash flows on a weekly basis at the start of your business, and then on a monthly and maybe quarterly basis as your business grows and becomes more stable.
Here are a few important points about budgeting that can get you started on using this powerful tool in your business:
#1: What Is A Budget?
A budget is a financial plan that shows your planned income and inflows against your planned expenses and outflows. It is an important tool that helps organizations – big and small – to plan their finances effectively.
When properly implemented with the right discipline, a budget will ensure that you are able to aggressively pursue your income targets and hold yourself and your employees accountable for these targets, while keeping operational and capital expenditure in check, in line with the limits set in the budget. It is important therefore that you use budgets each year to discipline your organization in a realistic manner.
#2: Preparing A Budget:
To prepare your budget you need to look at your current financial records and try to peek into the future. The first step is to have your current financial data on hand – this is where having proper accounting records helps.
With your current financial data, you can then project for each item of expense and income the expected growth or decline. For example, if you had income items like Nursery School Fees of N1,500,000 per term, you can decide that based on an expected increase of pupils from 15 to 20 by the next term, your Nursery School Fee income should increase to N2,000,000.
You can then also project for example that your classroom materials expenses will go up by about 15% to accommodate the new pupils. For each item of expense (outflow) and income (inflow) you have to set a realistic expectation.
While preparing your budget, you also need to look at the effect of seasonality on your business. For example, are there specific months when business sales are low or operating expenses are high for any particular reason? This seasonality will have to be reflected in your budget.
Restaurant sales typically increase in the holiday seasons especially in December, so the forecast income for a restaurant owner in December and January should reflect this. Another important consideration that your budget must have is with regards to the acquisition of equipment and other large assets.
These things may not show up in every year’s financial statements, so if you plan to purchase new fixed assets or replace existing ones during the year you should also include them in your budget.
Finally, in preparing your budget, you need to be as realistic as possible, so that you can use the budget effectively as a planning tool. If you set overly high expectations for income growth or expense reduction without having a clear strategy of how to meet those expectations, your budget can become unrealistic and you may truncate the entire process.
#3: Tracking Your Budget:
Now that you have created a budget, you must begin to track and measure performance against your budget. Going back to the two major activities captured in your budget – Income and Expenses, you need to track each item under them properly. For example, telephone expenses have a budget of N30, 000 per month.
The idea is that once you reach a critical level in terms of that amount, say 60% you should begin to watch the expense, especially if you still have more days in the month to run. It means that once you expend the budgeted amount of N30, 000, you can no longer incur and approve any telephone expenses until the next month.
By continuously monitoring each item against the budget in this way, you can create a more disciplined organization. The same applies to your income – you should be able to track your income each month and measure performance against the budget.
You can link budget performance to bonuses and other incentives that you pay your staff and yourself, and get everyone focused on and concerned about driving business income.
By monitoring your income, you can take proper decisions like stepping up your marketing efforts and coming up with more innovations in product development. Without the discipline of a budget, things may continue to slide and get worse without you doing anything concrete until the year ends.
#4: Revising Your Budget:
From time to time, you need to evaluate the budget and decide whether you need to revise some of its estimates based on some of the realities on ground.
You may have made some assumptions about business growth or the introduction of a new product which can no longer happen and so it may be important to re-do your budget to reflect this reality as soon as it becomes apparent. Typically business owners sit to review their budgets quarterly and decide if there are any items that need to change, especially due to circumstances outside their control.
Remember, while your budget should be ambitious and stretch your team, it must always be as realistic as possible to be used effectively as a management tool.
#5: Using Your Budget:
To build a truly disciplined and focused organization, it is critical for you to create and use a budget. If you have made an investment in a computerized accounting system, the budgetary provision for each item can be captured, and you can review your actual performance vs. budgeted performance on a weekly basis.
You will be amazed how easy this is, and even more impressed by how much constant reviews like this can help you and your employees move your business forward. It is interesting to note that even CEOs of big companies – banks especially, review their balance sheets and income statements on a daily basis, comparing it with their budgets and taking appropriate decisions based on the trends and/or gaps that they see.
For example, if you notice a trend where customers are not paying on time for services and bad debts are on the increase, you can tighten your credit terms to customers and begin a massive revenue collection drive to close the gaps. By deploying the immense power that budgets offer to your small business, you are well on the way to becoming a business empire!
We have tried to make budgets seem as simple and practical as possible to create and use, but you will have to make a choice about when you should create a budget for your organization and start using it. The earlier you do, the better!