As a business owner, developing a clear picture of your company’s financial situation and business strategy is the single most important thing you can do. For new entrepreneurs, it can also be one of the most difficult aspects of managing a business.
Your budget is a crucial process for your business. It helps you understand cash flow, estimate costs, project revenue, and ultimately plan to achieve growth. Without a good budgeting process, it’s nearly impossible to understand how your business can and is performing at a macro level. Clear, accessible insights into your finances are the key to ensuring your company is prepared for the future and capable of succeeding long term.
Actively tracking your budget versus actual requires great attention to detail as well as a comprehensive view of your company’s entire financial situation. It is also crucial to make healthy proactive changes to keep your business profitable and in control. Below, we’ll walk through some tips to help you get started.
Creating Your Budget
The first step in understanding your financial picture is creating a budget. The complexity of your budget likely depends on the size of your business. However, all budgets consist of two components: revenue and expenses.
Identify All Revenue Streams
To create your budget, start by identifying all of your various revenue streams. Your revenue consists of all funds coming into your business. You’ll want to calculate and forecast at least 12 months of revenue.
It may sound simple on the surface, but volatility in your sales channels can make revenue projections complicated. You’ll need to work closely with your sales, marketing, and finance departments to come up with a system for accurately forecasting sales. For example, if your business relies on project-based fees as opposed to recurring monthly revenue, you’ll need to have a clear picture of anticipated closing dates to accurately predict revenue for the coming year. In general, it’s always helpful to be somewhat conservative when forecasting revenue.
Calculate Fixed Expenses
The next step is to calculate your “burn rate”. How much money is your organization spending each month regardless of unit sales or production? The first element of your “burn rate” is your fixed monthly costs. One of the best ways to get a handle on your fixed expenses is to review recurring fixed expenses. These are often captured in historic credit card and bank statements as well as your obligations under any existing contracts. Real estate and facility costs, equipment payments, payroll expenses, insurance, taxes, office supplies, and business tools/software are common examples of fixed costs. Every business is different, so you’ll need to develop your own comprehensive list.
Plan For Variable and Unexpected Costs
Not all expenses are fixed. Many are variable and some are out of your control. Your business is also likely to face unexpected, one-time costs. You’ll need to account for all of this in your budget.
For variable costs, you can take the average historical monthly spending, or to be conservative, take the maximum monthly cost of each recurring expense over the last couple of years and add that into your expense column.
For larger, unexpected costs, it’s always wise to create a savings fund to prepare. Add monthly contributions to your savings fund as a line item on your expense sheet. Also, do not forget to plan/provide for vehicle maintenance, equipment repairs, etc. at some reasonable rate. Usually, a fund of roughly 10% of original capital costs is a reasonable estimate.
Tracking Budget Vs. Actual
As you move throughout the year, make sure to keep a close eye on the variance between your budget and actuals. You can achieve this by creating a simple profit and loss statement (P&L). When subtracting monthly expenses from monthly revenue, you may notice a positive or negative variance. You’ll want to be sure to identify and document the drivers behind the discrepancy. If your variance is negative, perhaps a sale didn’t close or your marketing isn’t performing. Maybe you faced an unanticipated expense. If your profit margin variance is positive, perhaps your sales are exceeding the forecast or you reduced monthly expenses. Regardless of whether your variance is positive or negative, always drive towards the why. Keep digging until you understand the reasons for the variance, and know-how to bring things back into alignment with your budget.
Understanding the variances in your budget vs actuals over time can help you derive macro-level insights into your company’s performance. Are you growing at the right pace or falling short in the market? Are your advertising and customer acquisition efforts effective? Are you overspending? As a company leader, use your financial data to identify patterns and find the answers to these burning questions.
Getting your arms around your organization’s financial picture and business strategy is a challenge for any leader and one of the most common reasons leaders turn to business consultants for help. If your business needs help getting its finances in order, contact Lilly Consulting Group today. We’d be more than happy to help create a financial budgeting process that helps you understand your business performance.