So, you’re back to build your own budget. If you need a refresher on budgeting methodologies, be sure to check out part one here. Once you’ve determined your methodology for creating your budget, it’s time to work through the steps to complete it. Ironically, for a process titled BYOB, there’s a 12-step program for building your budget. Let’s get started!
Your revenue is your inflow of income and is a natural starting point. Consider your major revenue streams like existing or new product lines, specialty services, or e-commerce. Use conservative estimates on revenue, and be sure to factor in factors like local economic conditions, seasonality, and geography, if you have more than one location.
Many costs are easy to estimate and are often stable or fixed costs. Often they come from utilities, rent, accounting and legal costs, or marketing. Drop these into place first. Then move to variable costs, or costs that fluctuate based on activity or seasonality. A good example of this type of cost is commission for a sales person based on their production. Lastly, prepare for big ticket items. It you foresee a significant capital expenditure coming on the horizon, plan for it in advance to minimize the impact on cash flows.
Identify Your Key Metrics to measure how you’re doing. In a for-profit environment, generally the first one to consider is profit margin. Other good ones to consider are inventory, AR, and AP turnover as well as liquidity, current, and quick ratios. Using a budget-to-actual comparisons in addition to year-over-year performance comparisons are a great way to track your progress against expectations and prior history.
Forecast out your 12-month cash flows. Remember that accrual accounting can be very different from actual cash flows, and its cash that keeps the lights on. You may be earning revenue for the sale of goods or a service, but it’s converting that receivable into cash that will help the business. Make it easy for your customers to pay you. Utilize online options, merchant services, and ACH transactions to collect funds faster, and on the payables side, manage your outflows by adjusting payment times a little further out.
Any time you are holding a receivable, you are extending credit to your customer. Most customers make good on their debts, but not all do. Even when they do, it may be a lot further down the road than you want. So, understand the terms of the credit you extend, work with quality customers (to the extent that you can), and adjust your expectations for those that simply slow pay out don’t pay.
Many businesses are seasonal—there’s just not much demand for Christmas tree lights in July—and if that is your type of business, make sure you research the demand of your industry. When it’s your time of year and you’re flush with cash, set some of it back for the leaner months. Develop a workforce that is flexible and adaptable to the changing conditions.
The only thing constant is change. Your company needs to be nimble, and in order to guide it, you need to keep up with industry trends. Economic trends factor into your budget through the changes, both positive or negative, that they cause, and the first place you’ll see it is in your KPIs.
To the extent possible, try and get as many expense as possible to be fixed or reasonably stable costs. Many companies also utilize a separate capital expenditure budget that helps plan for significant cash outlays. Additionally, understand the return on investment that you get for your expenses. For example, with marketing, think about your end goals for your spend. Is it to raise awareness of the brand? Is it to tap into a new market? What are the KPIs that you expect to see?
In order for your budget to be useful, there must also be an element of accountability. That begins with the buy-in of segment or department leaders. That’s not to say that all unplanned expenses are bad; it just means that there needs to be sufficient justification for extra spending. Try to identify unique projects that are not part of recurring operations. Most importantly, tie budget targets to performance evaluation.
When you have excess cash on hand, it’s awfully tempting to spend it. However, another way to use those funds is to consider investing them, either back into the company or into financial markets. Beyond investing in markets for a rainy day, also consider the use of funds in training and development or staff expansion. These types of investments into operations often yield tremendous returns.
Periodically (and in my opinion, at least quarterly), you should be reviewing your actual performance against your budgeted numbers. Both under and over-performance should make you pause and dig a little deeper. Underperforming products, divisions, or segments of your business are never good, but be wary of over-performance as well. You may have missed an expense in your budget somewhere. On a positive note, over-performance could also be a sign that there are efficiencies that can be replicated and used again in the future. Lastly, a great way to communicate financial information in a budget review is through dashboards and other graphical elements.
Always have a backup plan for your success. Fifteen months ago, no one could see that we’d still be a year into the pandemic. Having a rainy day fund invested will help; so, too, will understanding your industry. You have to consider that the loss of a major customer, vendor, or supplier is imminent, so how does the business continue when one of these leaves? Also, this is a good time to remind you that you should review your insurance coverage at least annually—particularly for cybersecurity coverage.
Well, you’ve done it. You’ve successfully completed your 12-step program on budgeting! If you have any questions, need some help, or just want someone to come and review your budgeting process in an effort to retool it, we’re happy to help. Reach out to one of our advisors today!
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