Creating a budget process is one of the most effective methods of keeping your business, and its finances, on track. You are “open for business” and now it’s essential to plan and tightly manage your business’ financial performance.
When you are running a business, it is easy to get bogged down in the day-to-day operations and lose sight of the bigger picture. One thing that all successful business owners do is invest time in creating and managing budgets, preparing and reviewing business plans, and regularly monitoring financial performance. By implementing a structured planning process you will be able to focus on improving profits, reducing costs and increasing your returns on investment.
STOP! If you are thinking “but I just have a small home-based business” or “this only applies to big companies”. Do you want to have a successful business or not? If not, you might as well stop reading right now. If yes, then get ready to buckle in and do some work because today is the best time to start thinking about putting a formal process in place. This doesn’t have to be difficult or time-consuming. What is important is that you have a plan, it is dynamic and it is communicated to everyone who has a stake in it.
Benefits of Annual Business Planning
The most important benefit of business planning is that it allows you to create a direction for your business and establish targets for growth. It does this by providing:
- improved focus and clarity
- sound financial information on which to base decisions
- a platform for making continuous improvements and anticipating problems
- greater confidence in your decision-making (no more “squirrel!” or shiny object syndrome)
Your Business Planning Cycle
If you are going to formalize your planning process, the first step is to outline your planning cycle. So let’s say you are going to start the process today. The first step is to review your financial performance against last year’s performance as well as against the targets you set for the current year (that is if you set them).
Next, take a look at your successes and failures over the past year. Write them down. What have you learned over the past year as a result of the failures? How about the successes?
What are the opportunities and threats for the coming year? Will a change in government bring about changes in taxation, the value of our dollar or in regulations? What is happening closer to home in terms of local economy, competitive environment or market?
What are your longer-term objectives? do these need to be changed or re-established? What are your key objectives for the coming year? Make sure they move yu towards those longer-term goals.
What resources will you require to implement your plan? Build a budget (more on that later).
Define your new financial year targets for your income statement and balance sheet. This includes revenue, expenses, profits, assets, liabilities and owner’s (shareholders’) equity.
Finalize your plan.
Review your plan regularly. Seriously, if you go through the process of creating a plan and then put it in a drawer you are wasting your time. A best practice is to review it monthly, monitoring performance in terms of financial as well as progress towards objectives and KPIs.
Rinse and repeat.
Things to Include in Your Annual Business Plan
The purpose of establishing a plan in the first place is to set out the strategy and action plan for your business over the coming year while keeping an eye on longer-term goals. In preparing your plan you will want to include:
- a clear financial picture of where you stand now, and where you expect to stand over the coming year
- an outline of potential changes to your business environment including your market, your competition, and your customers
- your goals and objectives for the coming year
- any key performance indicators (see our post on Establishing Key Performance Indicators)
- information about your management team and people
- an outline of any changes you want to make to your business, whether this is adding products or services, changing locations, or streamlining operations
- any anticipated issues or challenges
- details of investment in the business, current and anticipated
Budgeting as Part of the Business Planning Process
All the plans in the world won’t help you if you don’t have a way to fund those plans. Preparing a budget is the best way to control your cash flow so that you are able to invest in new opportunities at the right time. Your budget is a vital tool in controlling expenditures. Your budget is your financial plan allowing you to
- Control your finances
- Ensure your ability to fund your current commitments
- Help you make confident financial decisions in meeting your objectives
- Ensure your ability to fund future projects
It sets out what you will spend your money on and how you will finance that spending. While a financial forecast helps you predict the future, your budget is a planned outcome of the future of your business.
Benefits of a Budget
By having a business budget you will be better able to manage your money effectively. It allows you to
- Improve decision making – if it’s not in the budget you either have to say no or reduce expenditures in another area to compensate for saying yes
- Meet your objectives – by planning expenditures around those objectives
- Measure your performance – are you meeting your revenue objectives? If not, do you need to reduce expenditures accordingly? Or will you implement a strategy to increase sales?
- Allocate resources to projects effectively
- Identify potential problems such as the need to raise financing or experiencing a cash shortage
- Plan for the future
- Improve staff motivation by involving them in setting targets and rewarding them as they meet them
Creating a Budget
Your budget is simply your roadmap for what you are likely to earn and spend in the period. Creating, monitoring and managing a budget is key to the success of your business. It will help you allocate resources so that your business remains successful and profitable.
Your budget has three main areas: projected sales, direct costs of sales (Cost of Goods Sold) and fixed costs. Your business plan will include a forecast of sales, variable and fixed costs which is why we recommend creating your plan first.
In projecting your sales, be careful not to overestimate. Use your historical sales to guide you, taking seasonality into account. For example, when I was preparing budgets for my real estate company I would calculate the percentage of sales that occurred each month and apply those percentages to my annual sales target to create a monthly budget. In setting sales targets, consider having each member of your sales team provide you with their goal for the coming year. Give some thought to how changes in the economy, competitive environment and your customer base might affect sales.
Direct Costs of Sales
Direct costs of sales include such things as costs of materials or subcontractors to make the product or supply the service. These costs rise an fall with sales so you will want to know the unit cost and then apply that to your sales forecast.
Fixed Costs or Overhead
Fixed costs include everything you have to pay whether or not you make a sale. These should be itemized by type:
- Premises – including rent, taxes, and service charges
- Utilities – heat, light
- Wages – including the employer share of CPP and EI, and any benefits programs offered to employees
- Advertising and Promotion – including traditional and digital advertising, trade shows, website and so on
- Accounting fees – include the cost of your bookkeeper here if they are not an employee
- Office expenses – such as postage, stationery, and printing
- Vehicle expenses – including fuel, insurance and repairs, and maintenance
- Equipment costs
- Travel expenses – including accommodations and meals
- Legal and professional costs
- Insurance – property, general commercial liability, business interruption, errors and omissions (if applicable)
Depending on the size of your business, you may find it useful to divide your budget up by department, such as marketing, sales, and operations. In this case, have the head of each department submit their budget to you as a starting point for finalizing your budget for the business. This practice also helps managers “own” their budget and makes them more motivated to meet it.
Using Your Budget to Measure Performance
Your budget is the financial action plan that arises from your business plan. It has several uses. It provides you with the revenues and costs associated with each of your business’ activities. By providing information, it supports management decision making throughout the year. It allows you to monitor and control your business by analyzing the differences between budgeted and actual figures.