Better business budgeting: making a more effective plan

Did you work out a budget for this year, as per normal? Have you thrown it out yet?!

It’s easy not to bother at the moment; the last few years have shown how little certainty we really have when we try to plan ahead and the last 12 months have made it clear that that’s not changing anytime soon.

So why bother with a budget?

In my experience making your own predictions of how sales and costs are going to pan out during the year gives you the background to make order out of chaos. What is the coming year likely to look like? What needs to happen to do to keep all those plates spinning and what power do you have to influence it?

Budgets were first developed in the early 20th Century as a way of keeping financial control on a business. The thinking was that analysis enabled business managers to control spending. But is a budget an effective tool to limit spending or grow sales? I think we would all agree that the 21st Century view is that it NO.

First of all, there are three distinct ideas wrapped up in a budget; strategy analysis, target setting and resource allocation, and that’s where I’d say the theory starts to fall apart. You can’t balance the best case outcome and the worst case outcome in one document without reaching a hopeless compromise.

Strategy Analysis
It’s easy to think of a budget as a plan for the year, but actually it’s more of a description, in numbers, of what you expect your plan to deliver.

Life very rarely goes to plan, but understanding what the world will look like if your business strategy plays out allows you to check you’ve got the right strategy. Will your growth plans deliver the anticipated results? Can you declare the dividends that you are expecting to pay?

A budget allows you to check you’re heading in the right direction.

Target setting
Targets are usually about sales, but regardless of subject a target is always something you want to achieve (or will be a challenge).

If a budget is going to be reliable you’re going to want to keep your sales figures realistic. But how motivating is a sales target that is safe and achievable?

While right at the moment keeping up with last year’s sales may be a challenge in itself, a good sales team will always be aiming for bigger and better.

Yes, the figure used in a budget needs to be “expected” sales, but target setting should be handled separately. There is no real compromise between achievable and motivating.

Resource Allocation
Overhead costs often feature in a budget as a consequence: an uncontrollable add on (or actually a deduction) from sales: staffing costs £x, marketing costs are the same as last year, the insurance cost has increased so something else has to be reduced to keep the balance.

This is not financial control!

First of all there will be interdependencies – controlling cost may mean you haven’t got the capacity to fulfil new sales orders, etc. So the staffing budget needs to be detailed and reflect the strategy.

Marketing spend, and lots of the other costs need to be planned and matched to specific activities (drivers) rather than just using last year’s figure, or a plain percentage of sales. Marketing in particular is a topic for another post, but my message is that this is the time to stop and think about how the bills added up last year and choose what you want to do this year, not simply repeat ad infinitum.

So effective budgeting needs to balance these three competing features. There are other ways that your budget can become more effective though:

Communication
With all of this planning it is important that creating a budget is always a two way process. This is another flaw in the original theory of budgeting. It’s easy for finance to pick a number and run with it, but the people who are talking to suppliers are the ones with the real information. A successful budget involves integrating the plans and barriers for all departments and decision makers.

Challenge
One of the problems with budgeting like this is that sometimes the budget will show a loss on the bottom line, which can be difficult to accept.

The reality of growing a business is that you continually invest in growth so there may not always be a rosy profit available. It’s important not to distort the predictions simply to make the budget look more reassuring. It takes action to change the numbers, it won’t work the other way round. This is where a cashflow forecast is important; in the short term profit is less important than cash and if previous investments are paying off there may be scope to stomach a loss this year.

Review
It’s easy to create a budget at the beginning of the year and leave it at that. But the real power of a budget is to compare real life to what you expected would happen, and work out what action you need to take as a result.

In addition to this there are no rules about how regularly you should review/ update it. It is worth keeping it up to date. If you started last year with monthly sales of £40,000 and in March half your customers closed for several months a comparison between budget and actual sales would not have told you anything about the effectiveness of your subsequent actions.

I like to review budgets at least quarterly to make sure the information is up to date, but its not unheard of to review them several times in a quarter as the facts change.

Good information is the key to making good decisions. Cash is always my first priority, but a well thought out budget is the source of the information you need to make your cashflow forecast and keep your business going, and growing successfully.

Look out for more blogs here talking about how budgets can make your business more effective, and if you would like help reviewing your current budget then get in touch.