Question: Our startup only began operating this year. As the year end is fast approaching, we thought that it will be a good idea to start reviewing our operations and plan our budget for next year. Do you have any advice on how to do this properly? – Miggy
Answer: Every startup needs a budget to succeed in business. It is one of the most important tools in the early stages of a business. A budget acts like a financial roadmap that guides you to generate the most value for your business using your limited capital.
Budgeting need not be complicated. It is simply an exercise of understanding how your business operates and planning your expectations and priorities in financial terms. Having a budget helps you to focus on the value-adding activities of the business by identifying opportunities to lower costs and increase your sales.
A budget will not be meaningful if it is not implemented properly. It will only be effective if it is prepared and developed carefully. Here are the 7 budgeting tips that every entrepreneur must observe:
1. Make your budget on cash basis.
Traditional accounting will tell you that if you sell something on credit, it shall be considered sold and booked as accounts receivable. As a startup, your focus is cash flow. A sale on credit is not considered a sale until you have collected the cash. Build your budget based on projected cash flows. How much cash will you receive for the month after paying all the cash expenses?
2. Make not only income forecast but also balance sheet.
Preparing a budget for income and expenses is not enough. You also need to budget how much capital expenditures you will spend to support the business and how you intend to finance it. If you are borrowing money to invest a portion of your capital expenditures, you also have to budget how much your monthly repayments will be. Budgeting for fixed payments for interest and principal is critical, for it does not only affect your cash flows but also your projected income.
3. Make your budget realistic and achievable.
A wishful budget is nothing but fantasy. It surely feels good to project rosy figures for your sales but if it is not going to work, it is useless. Align your budget to reality to avoid disappointments in the future. It will always be helpful if you under promise your projections. Always assume the conservative scenario. How low is your break even sale? How many months can your business survive if your sales don’t turn out as projected?
4. Make your cost budget productive
While you need to list all your anticipated costs in your budget, you have to carefully evaluate every item that you plan to spend whether they are urgent or not. Use this opportunity to study your business model on how to drive your profits higher by constantly challenging your costs and sales assumptions. There may be expenses in the budget for which you can afford delay without affecting your operations. There may be some items that you have conservatively over-budgeted. Make your cost items efficient. If you spend this particular expenditure, how does this item help in increasing your sales? How soon can you recover this particular cost?
5. Make your team agree to follow the budget
Once you have finalized your budget, you must get the support of your management team. If your team expects that they will hit certain target sales, get their commitment by asking them to individually sign their name on it. By getting them to commit, you will make them accountable for what they have promised to deliver. Your budget will also be the basis for settling any disputes on spending, as well as performance evaluation in the future.
6. Make your budget the ultimate guide for planned expenses
A budget will only have value if it is followed properly. Unless you have very good reason to justify any expenses that are not part of your budget, always try to stick to your plan. There will be times when you have to pay a little bit more and there will always be variances. It will be good if you have monthly review of your actual and budgeted expenses and identify any significant discrepancies. Discuss this with your team on how to improve it and bring your spending back according to the budget next month.
7. Make revisions to your budget if necessary
A budget is prepared based on certain assumptions about the future. There may be some assumptions that may no longer be relevant. For example, some items may have higher actual costs than their budgeted costs due to price increases. There may also be some marketing expenses that you need to spend in order to get big clients that are not part of your budget. Or your target sales may become unrealistic due to a slowdown in the industry, and you may need to scale it down. These are some of the situations for which you need to update your budget.
Henry Ong, CMC, is president of Business Sense Financial Advisors. Email Henry for business advice email@example.com or follow him on Twitter, @henryong888.