The importance of budgeting

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Budgeting can give you a road map to follow for your business. It can also help you to further reduce costs.

In good times it’s easy to become relaxed about budgets and profit & loss reports because there is plenty of income, but when times get tough it’s important to also look closely at where the money is being spent. I recently went through this exercise in my own business and came up with approximately $250,000 of savings per year. Some savings are tough to make but as a business owner, if you don’t make them, the cost could be coming out of your own pocket.

What are the key benefits businesses can gain from a good budget? The benefits are:
• A budget helps you to determine a break-even number therefore providing a target to aim for each month.
• A regularly reviewed budget enables you to compare against actual performance and quickly identify losses and take remedial action.
• Preparing a budget provides an opportunity to think about what you are going to spend and set limits for the business owner and staff.
• A budget allows you to plan operations and gives those responsible a better handle on things.
• A budget is required for lending and demonstrates good management.

How should businesses approach budgeting for any transition in business direction?

Growing your business requires financial as well as strategic planning. The first thing is to actually have a budget. Very few small businesses have one. The excuse we often hear is “I don’t know what my income will be, so how can I do a budget?” My answer to this is, what most businesses should know is their expected expenditure.

• You start by entering your fixed costs into a spreadsheet with a column for each month of the financial year, plus a total for the whole year. Fixed costs are those that you incur whether you sell anything or not eg rent, wages etc.
• List all of your fixed costs items by line and using the previous year and your expectations for the coming year, enter a monthly figure for each expense item.
• Enter a total formula for each month and the full year of expenses.
• You now know what your break-even point is for each month and the year. Break-even is the amount you need to sell to create neither a profit nor a loss but a $0 result.
• If there are variable costs such as product purchases or labour, if it’s a service business, enter them just below the income. Variable costs are those that are incurred only when a sale is made.
• Enter a formula deducting the variable costs from the income to give a gross profit figure.
• Now add a final formula at the bottom deducting the fixed costs from the gross profit to get your expected net profit figure.

Once you have done this you have something to aim for and work with. Each month you replace the budgeted figures with actual to create a “rolling budget” which will tell you what your yearly results will be if you meet budget in the remaining months of the year. This can be a very enlightening exercise and show where you need to focus attention on both income and expenditure.

Note: this can be the basis of a cashflow forecast by removing any non cash items such as depreciation and entering an opening and closing bank balance for each month. You would also need to enter any non profit & loss items such as GST and Capital Expenditure.

By doing this you will see the monthly future bank balance and where any extra funding may be required.

Budgets should be reviewed monthly. This can be done by entering your budget into accounting software and printing an actual versus budget, profit & loss report at the end of each month.

A budget is a guide to financial performance of the business and a way to quickly identify overspending and potentially loss making situations. The sooner this is done the less money that is lost or wasted.

How can businesses reassess their expenditure in difficult times? The best way to reassess expenditure is to set aside some time to work through every line of profit and loss report for the previous year, and ask yourself the following questions:

• Is there a better way of achieving this outcome?
• Is there a more cost effective way of doing this?

What are some common changes businesses can make to their budgets during periods of cash constraints? Have a look at the high percentage of spending and look for ways to minimise them.

For example if you operate from rented premises have a look at the amount of space you occupy. Is it appropriate for the business now? Things change and what was appropriate in the past may not be the same now. Moving a business may seem like a traumatic event, but if it’s going to make big savings to the bottom line perhaps it’s worthwhile.

Another example is telephone and communications services. Have a close look at what you’re spending and the providers you’re paying. I was amazed when I looked closely at ours – we were paying eight different providers. Some of them were totally unnecessary. We saved approximately $1000 per month by changing and consolidating our providers.

A sensitive area is staff. This can also be a huge area of savings. Many SMEs don’t have an organisational chart – a clear picture of who does what in the business, and very few staff have job descriptions. This happens often as a result of years of growth in a disorganised manner. If you sit down and think laterally about what needs to be done in the business and who is doing it now, big savings and efficiencies can be achieved.

In summary, a budget won’t magically solve your financial difficulties, but it will serve as an early warning device. You will be in a position to see the situation within one month as opposed to many months if you wait for your tax accounts at the end of the year. When you do identify areas where you can make savings, any short-term pain from making these changes will be long forgotten as your bottom line quickly improves.

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Resources

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Individuals

Tax Rates

Checklists and Downloads

Superannuation

Estate Planning

Starting a New Business

BAS & GST

Business Planning

Employing People

Cloud Accounting

BAS Lodgements

Companies

Business Planning

Individuals

Lodgement Dates

Trusts & Super Funds

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