Budgeting benefits | Laying out revenues and expenses will help you sleep better and make more money
“You need to create an annual budget for your business.”
You’ve heard this advice over and over again, but you still don’t have a budget because:
You don’t really know how a budget will help your business
You think a budget will just sit on a shelf gathering dust, so you don’t want to waste time and effort creating one
Your business has been running fine all of these years without a budget, so why start now?
The word “budget” has a bad reputation as something mysterious, complicated and not very useful. A budget is simply a numerical summary of your business activities. It puts a dollar value on all of the planned revenues and expenses for an upcoming time period (usually a year). Better yet, a realistic budget can help improve the profitability of your business.
The following are some reasons to rethink creating an annual budget:
Provides a complete review of your revenues and expenses. Another way to think of a budget is as a summary of how your customers, vendors and employees contribute to the success of your business. You know who your customers are, but do you know exactly how much money they contribute to the gross profit of your business? You pay vendors and employees each month, but how do they add value to your business? Creating a budget helps you clarify your revenue streams and forces you to look at individual expenses in a more detailed way. One client I worked with found several unnecessary expenses as we worked through the budget process. This gave the client immediate savings that flowed directly to the bottom line.
Forces you to define the impact of any new initiatives. Want to pursue a new business segment? A budget can help you quantify the proposed revenue and expenses related to this new endeavor. Planning to move to a new location? A budget can help you understand the bottom line impact of this change. Not fully understanding the financial impact of both revenues and expenses can lead to financial and business disaster. Putting assumptions and numbers on paper forces you to think through the impact of new ideas and changes.
Tells you when to worry and when to celebrate. Most business owners stay awake at night worrying about their business. Are revenues too low? Are expenses too high? Is the business where it needs to be? A good budget can help alleviate these worries, since you can easily see where your numbers are supposed to be on a year-to-date basis. An annual budget, divided into monthly increments, can tell you when to worry and when not to worry. Most business owners would lose sleep if their business lost $10,000 one month. They might be more relaxed if they knew they were budgeted to lose $15,000 that month and their YTD actual vs. budget report showed their net income was $5,000 better than planned.
Points out areas of concern and opportunity. A budget can help you better understand the financial drivers of your business. One client wondered why they were making less money than their competitors. We reviewed their financial information and noticed a large variance between the budgeted and actual labor expense for cost of goods sold. Luckily, this was the only area of their business showing a significant variance. The ability to compare budgeted versus actual results allowed us to focus on one aspect of the business that could immediately result in increased profitability. Instead of wondering what the problem could be, we found the issue, created a plan to specifically address the labor expenses and decreased the COGS in a short period of time.
How and when do you create a budget? Believe it or not, now is the time to begin thinking about your revenue and expenses for 2012. A good way to start is to review your current financial information on a monthly basis. Create a monthly profit and loss statement for 2011 and transfer this data into a spreadsheet so you can easily adjust information to reflect changes you plan to make for 2012.
Do you think you will add or lose customers, equipment or employees? Make these adjustments and see how they impact the bottom line. Seeing these results on a spreadsheet will give you an indication of how the initiatives will impact your business. Once you have an annual budget you are happy with, load the information into your financial software so you can view actual vs. budgeted results during the year.
The ultimate goal of a budget is to help you better understand your business. The main drivers of a business become readily apparent as you go through the process of creating a budget. The time and effort will result in a tool that will help you better manage your business during the year.
Alison Hinson, owner of Alison Hinson MBA, LLC, can be reached at alison@alisonhinsonMBA.com. Read more Profit Motives here.
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