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Basic Budgeting

In this chapter, you will learn —

• The importance of budgeting

• How to prepare and update a monthly budget report

• What to do with the information

The purpose of this book is to take the basic information that you have about your business’s financial position and create a structured plan to maintain, track, and improve your financial performance.

Under half of all businesses that have fewer than five employees maintain a working budget, the most basic of management reports. These businesses give many reasons, including, “I can’t predict my sales” and “It takes too much time.” However, businesses that have been around for a long time understand the importance of tracking and planning. Without a solid understanding of your impending performance, it is nearly impossible for you to make intelligent financial decisions for your business.

Case Study

“See? I told you that budgeting was useless.” Joe banged his half-empty coffee cup down on the desk. “Over the last three months we’re nowhere close to where our budget says we should be.”

“Vivian, our accountant, explained that it was an ongoing process,” said Becky. “This is the first time we’ve ever sat down and looked at our operating performance. She said we’ll get better

at budgeting the more we understand our numbers.”

“Well, it all seems ridiculous to me.” He paced the floor of the office. “We said we were going to do $21,000 in revenue last month, and we only did $18,000 — which is pretty much the same as last year.”

“When we prepared the budget,” Becky explained, “we said that we were going to do a large mail-out to attract new customers. That’s why we budgeted an increase in sales.”

“Well, I just got too busy to do that,” Joe said quietly.

“And here is the impact on our numbers,” replied Becky. “That’s the point of budgeting. To understand what the numbers are telling us.”

The Monthly Budget Report

The monthly budget report is the most basic of all financial planning tools. It shows what the projected revenues and expenses are for your business for the next one to five years, on a month-by-month basis. The monthly budget report only shows revenues and expenses, not cash receipts and disbursements.

The cash flow report is discussed in more detail in Chapter 5.

The monthly budget report is a useful tool for predicting when sales will be high and when they will be low so that you can plan for those events. For example, if your sales are always at a low point in March, it may make sense to target your advertising during that period.

Where Do the Numbers Come From?

Go to www.numbers101.com for a free downloadable template.

The starting point for your budget plan is to know what happened in the past. Of course, if you are a start-up business, you won’t have any financial history to examine. We will discuss startups later in the chapter.

If you work on a computerized accounting program like MYOB or Simply Accounting, you most likely have historical information at your fingertips. Run your monthly income statement for the previous 12 months. This will give you an overview of your business’s financial performance for the past year. You should be able to note the seasonality of your sales and be able to explain the dips and peaks. If you can’t explain them, take some time to analyze the sales.

Find out who you sold to during those periods. This knowledge is the foundation of your planning, as knowing why and when customers buy from you helps you to plan the future.

Case Study

“You actually did very well last month in comparison to the budget on the expense side.” Vivian reviewed the figures with both Becky and Joe looking over her shoulder. “Your office supplies are down and so are your meals and entertainment expenses.”

Becky smiled at Joe. “When we first started to look at our numbers, I realized that we were buying our office supplies from the most expensive store in the city. I also saw that many of the clients we were taking out for dinner and buying hockey tickets for weren’t our good clients. We’ve become more selective in how to use that budget.”

Vivian said, “Well, you’re reigning in your expenses and it sure shows in your operating performance last month. Now, let’s project how much increased business you can expect from doing that mail-out and build it into your budget.”

Revenues

Let’s take a look at the revenue side of the monthly budget report first. Okay, so now you know what you did last year. How does it impact what you are going to sell next year? If you’re in a stable business, you should be able to expect that you will at least sell the same amount as you did last year. So that’s a start. However, it makes sense to always have your sales trending upwards. If you have planned special advertising and promotional events in the upcoming year, you should expect your sales to increase.

If you are a young and rapidly expanding business, look at your rate of growth over the past two or three years. If you are growing at an average of 20 percent per year, for example, budget a 20 percent increase in sales for the upcoming year. To measure your rate of growth from one year to the next, take the difference between the sales figures for both years and divide that difference by the total sales for the first year. For example, if your 2002 sales are $50,000 and your 2003 sales are $67,000, your rate of growth is ($67,000 – $50,000) ÷ 50,000 or 34 percent.

Once you have mapped out your revenues, it’s time to look at your expenses.

Expenses

Again, looking over your business’s monthly income statement for the past year will yield important information about your expenses. You will find certain expenses that never fluctuate, like equipment lease payments and office rent. There will also be expenses that vary, either in step with sales levels or because of other factors. Examples would be office supplies and postage.

Start mapping those expenses that you know for certain. If you are locked into a three-year office lease, you know exactly what your payments will be for the next year. Then start filling in the other expenses. You will need to think about each one as you map it out. For example, if you know that you will be sending out 5,000 flyers in May, make sure that the projected cost is in youradvertising budget figure for May. If you are projecting a 20 percent increase in sales, you will probably want to increase your office supply budget.

Your wage cost deserves special attention. It’s important to make sure that you are including the full cost of your employees, not just the net checks paid to them. Depending on the regulatory environment in which you operate, you would also have to pay out things for your employee like pension, employment insurance, or health care premiums. These are all costs of having employees and should be included as a projected expense. Also, if you are projecting a big jump in sales, make sure that you can do it with the employees you have. If not, include the wage costs of new employees in your plan.

Chapter Summary

• Budgeting is a critical process for all businesses that want to last.

• Review your monthly performance from last year and make sure that you can tell the story of the numbers.

• Make sure your budget numbers are consistent with your operating strategy.

• Review your 12-month budget every month, dropping off the old month and adding one on at the end.