The one element that surrounds all business trouble is failure to plan. Business owners give plenty of excuses for not planning – they’re too busy or more pressing matters demand immediate attention. Remaining unburdened by budget planning appears acceptable… until it sabotages your success.
A budget is supposed to function in a reasonably simple way. It outlines how you will pay for necessities plus expand with occasional extra items. But when you believe a sufficient budget can exist completely in your mind, you’ve become a virtuoso in the art of self-delusion. To genuinely assure that your budget is sensible and meets its intended purpose, it must satisfy certain time-tested principles. That entails committing some time at year-end to exposing a written budget to close scrutiny.
Leverage Points
Start by fortifying yourself with an understanding of leverage points in your operations. Accomplishing this requires accurate recent financial statements. Obtain from these reports the key ratios that form assumptions in your budget.
Specifically examine direct costs for business projects, such as materials and labor utilized for processing billable work. Your gross profit margin is what’s left from revenue after paying direct costs. In general, whatever revenue you predict for next year will generate the same historical gross profit margin percentage. Accomplishing a different margin will necessitate cost containment. Growing revenue while incurring a slower rise of direct costs may seem like a hairsplitting triumph, but it delivers immediate benefit to bottom line profit.
Overhead Expenses
Firm knowledge of your general and administrative costs is crucial to reliable budgeting. Start with knowing which expense categories are the largest. Any meaningful budget – particularly one projecting optimistic improvement over the past – should reflect changes to the big dollar items. For variable costs, set an expenditure limit that’s a percentage of revenue. Your financial reports convey the historical percentages. Locking percentages in your budget for variable expenses results in flexible spending when future revenue exceeds or falls short of expectations.
Fixed costs are the most troubling expenses. They kill profitability during any economic downturn or period of slower than anticipated sales. You have to pay them no matter what and they’re difficult if not impossible to change once you lock them in place. Using your past financial statements, find out which fixed expenses have changed the most as a percentage of revenue. Fixed costs that present a rising burden for revenue growth to support are targets for revaluation. Lower rent, cheaper insurance, and reduced utilities usage are common goals for altering fixed costs.
Tying in Actions
Without an action plan, a budget is just a bunch of jumbled numbers that you hate to confront. What makes budgeting valuable is that it establishes a strategy for how you’ll manage your business. The tactical methods necessary to attain projected revenue are merely part of your strategic planning. Only by simultaneously executing the expenditure patterns in your budget are you assured of achieving your profit objective.
Analyzing expense patterns and creating realistically defensible budget allocations is a tedious process stretching over several days. But it’s far superior to suffering through an entire year of unmet intentions due to deficient planning.
The Finance Writer 