The New Year is a time when people often set themselves goals and think about the direction they want their life to take. In business, the process of setting goals forms part of setting your budget.
Budgets are important as they help to keep you focused on what you need to achieve to get where you want to be. They are a road map for success. We may not always stick to this path as plans change and evolve, but without a roadmap, how do you know if you are deviating too much and going off track? Budgets compel planning. They help to communicate your goals to your team and ensure that everyone's efforts are coordinated. They can be used to delegate authority and to motivate your team. They also enable you to monitor and control your results.
The Initial Steps in Budget Preparation
Your Aims -When preparing your budget, you need to ask "Where are we going?" and "How are we going to get there?"
Objectives and Strategy - Objectives are the targets you want to achieve. Strategy is how you are going to achieve them.
Relevant Data - start gathering together the data you need, both internal and external
Limiting Factors - these determine the level of output it is possible to achieve. They include the size of your market, the capacity of your premises, the availability of raw materials, the amount of working capital you have and the availability of skilled labour
Identify your key budget factor - one of your limiting factors will be key and your budget should be built around this. For many people, especially sole traders, the key limiting factor will be the time available to them to work.
Coordinate the Main Types of Budget
You will need to prepare a budget for each part of your business
Production
Material usage
Material purchase
Labour
Capital Expenditure
Cash flow
These component budgets will come together to give you a Master Budget consisting of a Profit & Loss, Balance Sheet and Cash flow Forecast.
Strategic Budgets look at your long term strategy and Operational Budgets are short term and focus on your annual plans.
Start with your Desired Profit
For smaller businesses and sole traders, it is a good idea to start with your desired profit. You can then work backwards by adding on your overheads (costs incurred whether you make sales or not) to get to your required Gross Profit. Your Gross Profit is your Sales less your Cost of Sales (costs only incurred if you make a sale). From here you can see the sales needed to achieve your desired profit level. Once you have this, you can see how realistic this is and start to look at ways to achieve it. If the sales budget is not realistic, then look at your overheads and cost of sales to see if you can find efficiencies there.
Beware though of cutting costs which are actually an investment that will help you to grow!
The Motivational Aspect of Budgets
Budgets can motivate or demotivate. Your budget should be seen as a personal goal, challenging but achievable. If you have a team, it is a good idea to involve those that have to work to a budget in the preparation of the budget. You can draw on their knowledge and experience and they are more likely to accept the targets that are set. Just beware of any budgetary slack that might be introduced!
Forecasting Techniques
The forecasting of your key budget factors needs to be accurate. Think about factors such as inflation. Will past trends be a good indication of future performance? When putting together your forecast you can use techniques such as trend analysis, market research and consulting experts.
Factors Influencing Forecasts
Product Lifesytle
Development
Launch
Growth
Maturity
Decline
Think about the effect these different stages will have on your profit and sales.
PEST Analysis
Political - eg minimum wage
Economic - inflation
Social - Fashion, family size, retirement age
Technology - effect on lifecycle
Dealing with Uncertainty
As the past few years have shown us, the future is never certain and can throw up unexpected curve balls. When preparing your budget, you can use techniques such as sensitivity analysis, scenario planning and what if analysis to allow for uncertainty. Flexible budgets can also be prepared based on different activity levels and are often used for monitoring and control.
Having a good understanding of your numbers
Key to all of this, is having a good understanding of your numbers in the first place. Using cloud software to keep your accounts up to date on a regular basis and using a bookkeeper to ensure you have accurate and up to date numbers, will help you to understand what is going on in your business.
Early detection of problems means they are much easier to fix. Planning for uncertainty means you are prepared when and if it happens.
If you need some help understanding your numbers or need to get some systems in place so that you have up to date accounts, then why not book in for a quick chat to see how we can help? https://www.wildbookkeeping.co.uk/contact-us
