Budgeting and business planning
Once your business is operational, it’s essential to plan and tightly manage its financial performance. Creating a budgeting process is the most effective way to keep your business – and its finances – on track … for Budgeting and business planning.
This guide outlines the advantages of business planning and budgeting and explains how to go about it. It suggests action points to help you manage your business’ financial position more effectively and ensure your plans are practical.
Planning for business success
When you’re running a business, it’s easy to get bogged down in day-to-day problems and forget the bigger picture. However, successful businesses invest time to create and manage budgets, prepare and review business plans and regularly monitor finance and performance.
Structured planning can make all the difference to the growth of your business. It will enable you to concentrate resources on improving profits, reducing costs, and increasing returns on investment.
In fact, even without a formal process, many businesses carry out the majority of the activities associated with business planning, such as thinking about growth areas, competitors, cashflow and profit.
Converting this into a cohesive process to manage your business’ development doesn’t have to be difficult or time-consuming. The most important thing is that plans are made, they are dynamic, and are communicated to everyone involved. See the page in this guide on what to include in your annual plan.
The key benefit of business planning is that it allows you to create a focus for the direction of your business and provides targets that will help your business grow. It will also give you the opportunity to stand back and review your performance and the factors affecting your business. Business planning can give you:
- a greater ability to make continuous improvements and anticipate problems
- sound financial information on which to base decisions
- improved clarity and focus
- greater confidence in your decision-making
What to include in your annual plan
The main aim of your annual business plan is to set out the strategy and action plan for your business. This should include a clear financial picture of where you stand – and expect to stand – over the coming year. Your annual business plan should include:
- an outline of changes that you want to make to your business
- potential changes to your market, customers, and competition
- your objectives and goals for the year
- your key performance indicators
- any issues or problems
- any operational changes
- information about your management and people
- your financial performance and forecasts
- details of investment in the business
Business planning is most effective when it’s an ongoing process. This allows you to act quickly where necessary, rather than simply reacting to events after they’ve happened.
A typical business planning cycle
- Review your current performance against last year/current year targets.
- Work out your opportunities and threats.
- Analyze your successes and failures during the previous year.
- Look at your key objectives for the coming year and change or re-establish your longer-term planning.
- Identify and refine the resource implications of your review and build a budget.
- Define the new financial year’s profit-and-loss and balance-sheet targets.
- Conclude the plan.
- Review it regularly – for example, on a monthly basis – by monitoring performance, reviewing progress, and achieving objectives.
- Go back to 1.
Budgets and business planning
New small business owners may run their businesses in a relaxed way and may not see the need to budget. However, if you are planning for your business’ future, you will need to fund your plans. Budgeting is the most effective way to control your cash flow, allowing you to invest in new opportunities at the appropriate time.
If your business is growing, you may not always be able to be hands-on with every part of it. You may have to split your budget up between different areas such as sales, production, marketing, etc. You’ll find that money starts to move in many different directions through your organization – budgets are a vital tool in ensuring that you stay in control of expenditure.
A budget is a plan to:
- control your finances
- ensure you can continue to fund your current commitments
- enable you to make confident financial decisions and meet your objectives
- ensure you have enough money for your future projects
It outlines what you will spend your money on and how that spending will be financed. However, it is not a forecast. A forecast is a prediction of the future whereas a budget is a planned outcome of the future – defined by your plan that your business wants to achieve.
Benefits of a business budget
There are a number of benefits of drawing up a business budget, including being better able to:
- manage your money effectively
- allocate appropriate resources to projects
- monitor performance
- meet your objectives
- improve decision-making
- identify problems before they occur – such as the need to raise finance or cash flow difficulties
- plan for the future
- increase staff motivation
Creating a budget
Creating, monitoring, and managing a budget is key to business success. It should help you allocate resources where they are needed so that your business remains profitable and successful. It need not be complicated. You simply need to work out what you are likely to earn and spend in the budget period.
Begin by asking these questions:
- What are the projected sales for the budget period? Be realistic – if you overestimate, it will cause you problems in the future.
- What are the direct costs of sales – i.e. costs of materials, components, or subcontractors to make the product or supply the service?
- What are the fixed costs or overheads?
You should break down the fixed costs and overheads by type, e.g.:
- cost of premises, including rent, municipal taxes, and service charges
- staff costs –e.g. wages, benefits, Québec Parental Insurance Plan (QPIP) premiums, contributions to the Québec Pension Plan (QPP), and to the financing of the Commission des norms du travail (CNT)
- utilities – e.g. heating, lighting, telephone
- printing, postage, and stationery
- vehicle expenses
- equipment costs
- advertising and promotion
- travel and subsistence expenses
- legal and professional costs, including insurance
Your business may have different types of expenses, and you may need to divide up the budget by department. Don’t forget to add in how much you need to pay yourself, and include an allowance for tax.
Your business plan should help in establishing projected sales, cost of sales, fixed costs, and overheads, so it would be worthwhile preparing this first. See the page in this guide on planning for business success.
Once you’ve got figures for income and expenditure, you can work out how much money you’re making. You can look at costs and work out ways to reduce them. You can see if you are likely to have cash flow problems, giving yourself time to do something about them.
When you’ve made a budget, you should stick to it as far as possible, but review and revise it as needed. Successful businesses often have a rolling budget, so that they are continually budgeting, e.g. for a year in advance.
Key steps in drawing up a budget
There are a number of key steps you should follow to make sure your budgets and plans are as realistic and useful as possible.
Make time for budgeting
If you invest some time in creating a comprehensive and realistic budget, it will be easier to manage and ultimately more effective.
Use last year’s figures – but only as a guide
Collect historical information on sales and costs if they are available – these could give you a good indication of likely sales and costs. But it’s also essential to consider what your sales plans are, how your sales resources will be used, and any changes in the competitive environment.
Create realistic budgets
Use historical information, your business plan, and any changes in operations or priorities to budget for overheads and other fixed costs.
It’s useful to work out the relationship between variable costs and sales and then use your sales forecast to project variable costs. For example, if your unit costs reduce by 10% for each additional 20% of sales, how much will your unit costs decrease if you have a 33% rise in sales?
Make sure your budgets contain enough information for you to easily monitor the key drivers of your business such as sales, costs, and working capital. Accounting software can help you manage your accounts.
Involve the right people
It’s best to ask staff with financial responsibilities to provide you with estimates of figures for your budget – for example, sales targets, production costs, or specific project control. If you balance their estimates against your own, you will achieve a more realistic budget. This involvement will also give them a greater commitment to meeting the budget.
What your budget should cover
Decide how many budgets you really need. Many small businesses have one overall operating budget which sets out how much money is needed to run the business over the coming period – usually a year. As your business grows, your total operating budget is likely to be made up of several individual budgets such as your marketing or sales budgets.
What your budget will need to include
Projected cash flow -your cash budget projects your future cash position on a month-by-month basis. Budgeting in this way is vital for small businesses as it can pinpoint any difficulties you might be having. It should be reviewed at least monthly.
Costs – typically, your business will have three kinds of costs:
- fixed costs – items such as rent, salaries, and financing costs
- variable costs – including raw materials and overtime
- one-off capital costs – purchases of computer equipment or premises, for example
To forecast your costs, it can help to look at last year’s records and contact your suppliers for quotes.
Revenues – sales or revenue forecasts are typically based on a combination of your sales history and how effective you expect your future efforts to be.
Using your sales and expenditure forecasts, you can prepare projected profits for the next 12 months. This will enable you to analyze your margins and other key ratios such as your return on investment.
Use your budget to measure performance
If you base your budget on your business plan, you will be creating a financial action plan. This can serve several useful functions, particularly if you review your budgets regularly as part of your annual planning cycle.
Your budget can serve as:
- an indicator of the costs and revenues linked to each of your activities
- a way of providing information and supporting management decisions throughout the year
- a means of monitoring and controlling your business, particularly if you analyze the differences between your actual and budgeted income
Comparing your budget year on year can be an excellent way of benchmarking your business’ performance – you can compare your projected figures, for example, with previous years to measure your performance.
You can also compare your figures for projected margins and growth with those of other companies in the same sector, or across different parts of your business.
Key performance indicators
To boost your business’ performance you need to understand and monitor the key “drivers” of your business – a driver is something that has a major impact on your business. There are many factors affecting every business’s performance, so it is vital to focus on a handful of these and monitor them carefully.
The three key drivers for most businesses are:
- working capital
Any trends towards cash flow problems or falling profitability will show up in these figures when measured against your budgets and forecasts. They can help you spot problems early on if they are calculated on a consistent basis.
Review your budget regularly
To use your budgets effectively, you will need to review and revise them frequently. This is particularly true if your business is growing and you are planning to move into new areas.
Using up to date budgets enables you to be flexible and also lets you manage your cash flow and identify what needs to be achieved in the next budgeting period.
Two main areas to consider
Your actual income – each month compare your actual income with your sales budget, by:
- analyzing the reasons for any shortfall – for example, lower sales volumes, flat markets, underperforming products
- considering the reasons for a particularly high turnover – for example, whether your targets were too low
- comparing the timing of your income with your projections and checking that they fit
Analyzing these variations will help you to set future budgets more accurately and also allow you to take action where needed.
Your actual expenditure – regularly review your actual expenditure against your budget. This will help you to predict future costs with better reliability. You should:
- look at how your fixed costs differed from your budget
- check that your variable costs were in line with your budget – normally variable costs adjust in line with your sales volume
- analyze any reasons for changes in the relationship between costs and turnover
- analyze any differences in the timing of your expenditure, for example by checking suppliers’ payment terms