By Tim Moore, EO Houston member and managing partner, TR Moore & Company, a Doeren Mayhew Firm
In my work as an accountant and business advisor, I find that the idea of working to a budget is foreign to the owners of many small and mid-sized businesses. Maybe they’ll need to develop one when their business grows, but meanwhile it’s altogether too time-consuming and would keep them away from the “real” work.
That thinking may need a little revision. The fact is, businesses that don’t operate to a budget are unlikely to grow, and if they do, they risk losing some control over growth-related fixed costs.
Year-end is an ideal time to create your budget as you look to the new year ahead. With that in mind, here are some budgeting basics.
- A budget has been described as a business plan expressed in numbers. At its simplest it looks like this: Estimated Sales minus Estimated Expenses = Profit (or Loss)
- In developing projections for a year ahead, you’ll be working in the dark to a certain degree, but anyone who has been in business for a couple of years will have the financial records to make a reasonable forward prediction of their sales and expenses based on averaging past years.
- You might call this your “no-growth” budget – you have estimated just the minimum necessary to keep the business operating.
- If you are interested in growing the business though, you work from the other end of the equation and set the profit margin you would like to (realistically) obtain. Once a profit margin figure for the year has been decided, a whole series of planning decisions cascade out from that: Is extra inventory required? Will you need to add more employees or move to bigger premises? Will you need to put more resources into marketing? All of these add to the “estimated expenses” portion of the equation. To cover them and achieve the desired profit, there needs to be extra “estimated sales.”
- If your aim is business growth, the starting point is to build a sound estimate of the extra costs and of the extra sales revenue necessary to cover those costs so as to reach the desired profit. These things can’t be left unplanned, the costs and sales merely guessed at, or the whole growth project will operate haphazardly, and you may out-spend your revenue and put yourself out of business.
Budgets are usually created for a 12-month period with month-by-month estimates of sales and costs.
That includes expenses that come up only once or twice a year, such as insurance, and spreading these costs out over several months. In this way you can plan ahead for the expense by trying to achieve enough sales each month to have the amount available when payment comes due.
Managing the Budget
As you conduct business during your budget year, you compare your actual figures to your budgeted figures. This needs to be done month by month and requires some discipline, but the payback is worth it. It will allow you to manage your spending so that you don’t overspend and cut into or eliminate your profit.
You will also be able to see if sales have met projections and will cover expenses. Where there are variances, ask yourself why the numbers are different. If some of your expenses, for instance, are higher than you expected, do you need to look for ways to cut them, or did business increase more than was expected and so add to your variables? If sales aren’t on track, what has happened to cause the difference and how can you improve them? Or would it be more realistic to accept they will remain low and trim future costs to match?
When you work to a budget you have one of the most effective management tools of all – a benchmark that you can use month by month to check your progress toward your business goals.