Entrepreneurs rarely find anything enjoyable about devising a budget for the year ahead. Consequently, the budgeting exercise is commonly neglected. Yet budgets offer advantages by facilitating planning, guiding cash management, and providing a comparison to actual results.
Of course, professionals reap these benefits only if the budget is useful. Giving attention to a forecast that results in gross inaccuracies and misjudgments is even worse than no budget at all. The key to making the budget process easy and accurate is to focus on six basic factors.
Expense Limits, Revenue Timing, and Capital Goods
Always begin your budget with projections of expenses. Fixed expenses are the simplest to address. These are recurring items such as telephone and internet service, office rent, professional liability insurance, and licensing or certification fees.
Next, examine variable costs, which fluctuate with revenue. After paying fixed expenses, you have limited cash available for variable costs, such as inventory, materials, and staff needed to complete sales. Your revenue is then based on your markup of these variable costs.
An additional factor to consider is how long it takes to get paid for sales. This could happen immediately, as in the case of a retailer, or a few months after project completion, if you provide billed services. Be sure to place your revenue collections in the appropriate periods of your forecast. You might need to pay another month of expenses before receiving the income from sales a month prior. And the initial months in next year’s budget may have incoming funds from jobs in your pipeline that you complete this year.
Don’t forget to include expenditures for capital goods such as machinery, equipment, and computers. For example, rising sales may at some point necessitate adding both a new worker and a new piece of equipment.
Substantiating, Duplicating, and Assessing
Verify your budget accuracy by comparing the numbers to the facts. These are crucial elements such as the number of potential customers in your market and how likely you are to connect with them based on your marketing costs. Identify how many potential customers turn into buyers. Determine the average purchase size. Overall, your aim is to ensure that your sales goal is realistic.
Turning optimism into pragmatism is achieved by forecasting multiple growth scenarios. The numerous factors at play are easily manipulated in a spreadsheet application on your computer. One scenario might modify the overall growth rate for next year. Another could change the pace at which your business grows. That is, you might end the future year at your optimistic sales level but get there more slowly.
Constant reassessment of your budget is vital. Maintain your forecast in a spreadsheet that allows you to recalculate upcoming projections as you enter each month’s actual results. Follow up each entry with a re-evaluation of the approaching period. Modify the forecast with a revised projected growth rate to match your recent activity. Change variable expenses and capital goods costs accordingly.
Lastly, review whether sales are rising faster or slower than expected. Based on this trend, consider whether you should expand or slash the fixed costs over which you have control. These adjustments will help keep your budget balanced and keep your business on track for success.