Budgeting is often a task that is not a key focus of small and mid-size businesses, but it should be. Why? Well, most importantly, the process prepares you to answer the following questions about what the next 12 months will look like for your business:
- What are you projecting sales to be next year?
- Are you expecting margins to improve in 2018?
- Do you plan to hire additional employees?
- Will you have any large capital expenditures in the near future?
These questions (and many others) are typical of investors, financial institutions, and potential strategic partners and financial buyers. Every business, regardless of their size, should have these answers so they can plan the annual budget accordingly.
If you are overwhelmed by the budgeting process, or just don’t know where to begin, below are some tips to help you get started:
1. Consult All Departments
The budgeting process should not be completed behind closed doors in an office by a member of the accounting or finance team. Instead, all of the departments within the company should be consulted on their expectations for the following fiscal year. This includes the sales team who can assist with realistic revenue assessments, the manufacturing or service team who can advise on costs of delivery and any large purchases required to update machinery, the research & development team who can discuss expected expenses as well as the timing on any new products anticipated, and so on.
Compared to creating a budget that estimates an overall percentage increase over the prior year’s actual income – which is far too common in most small and mid-size businesses – incorporating input from each department will result in more accurate and complete projections for the upcoming fiscal year.
2. Estimate Revenues
Expected sales have a significant influence on costs (including employee headcount), but can be very challenging to accurately project. Here are some ways to come up with the best estimate:
- Consider the recent monthly growth rate experienced by the company and decide if that is able to be continued.
- Review industry guides and other expert publications that focus on your industry and review financial information from a number of your competitors, if available.
- Communicate with your current customers to better understand their expected needs of your product or service.
- As mentioned above, discuss the expected sales with your sales department. This could also be a good opportunity to set expectations which will ultimately help determine compensation for this department.
3. Determine Expenses
Once the expected revenue figures are estimated, the focus can move towards the expenses. Here are some considerations:
- Some expenses relate directly to revenue, whether they be inventory or employee services. Typically the gross margin of a business does not fluctuate substantially unless new products are developed, inventory pricing changes or efficiencies are identified in the manufacturing process. Use this time to challenge your employees to identify cost savings related to the delivery of products or services.
- Other expenses are fixed costs such as rent, insurance, leases, and certain other services purchased. These expenses may be easier to estimate; however, consideration should be made to review policies in place, especially around insurance. Use this time to determine if better insurance rates are available or perhaps different coverages would be more advantageous.
- Employee compensation should always be established to be in-line with revenues and related growth in the future year. Many companies believe that all employees require annual raises, but if results show a contraction in the business, then it may not be reasonable. Consider tying aspects of compensation to the growth of the company.
- Along with compensation, estimating employee headcount is a critical aspect of the budgeting process. It is important to identify when you will need to hire, how long that hiring process takes, and what experience level would optimize the operations.
4. Identify Capital Expenditures
Often not considered in the budgeting process are those large or expensive purchases which are vital to the continued success of the business. These may include new computers, systems, machinery, vehicles, furniture, etc. It is important to keep in mind that each new employee hired will likely require a certain amount of capital expenditure.
Investments in equipment or processes that are directly related to your product or service should also be considered. Will you need to purchase any new equipment next year? Is there old equipment that needs to be updated? Avoiding investment in equipment can impact your output, quality, or delivery timing, which can directly impact your revenues.
5. Calculate Cash Flow
While it is great to be able to put together a projected income statement, it is just as important – if not more important – to calculate the expected cash flow of the business. These can be different considering that you may pay your bills faster than your customers pay theirs or you may need to purchase inventory well in advance of sales if acquisition time is significant. A cash flow statement can be created using the income statement as well as AR/AP turnover rates and other metrics from the balance sheet.
6. Be Conservative
While it may seem advantageous to show investors that the company will significantly grow, eventually actual results may disappoint. Even worse, business decisions may have been made using such projections. When in doubt, it is a good idea to be more conservative and leave some “slack” in the projections in case sales goals are not reached or are delayed.
7. Start Early
Businesses should begin the annual budgeting process by October to allow sufficient time to ensure the best-detailed estimate is completed by year-end. However, an annual budget should be monitored and updated on an ongoing basis, so it’s never too late to get started.
8. Monitor, Evaluate & Reforecast
Once you complete the budgeting process, the biggest mistake you could make is to file it away only to pull it out again at the end of the following year.
A budget should be monitored on a monthly basis, or sometimes even on a weekly basis for smaller companies.
Budgets should be edited if circumstances change. Furthermore, budgets should always be compared to actual results to understand why there are differences. This will help monitor spending money throughout the year and help management make key decisions in relation to the business.
We Can Help
Signature Analytics will help guide your company through the annual budgeting process. We will work with your management team to create a budget for your business and monitor that budget throughout the year. This would include analyzing the budgeted versus actual results on a quarterly basis and helping reforecast accordingly. We can also perform industry and economy reviews to assist with the reforecasting process and provide benchmarking data.
If you want assistance creating (or improving) an annual budget for your business, contact us today for a free consultation.