How to build a financial budget for your business (and why you need one)
There are few words in the English language that conjure feelings of scarcity and deprivation like “budgeting”.
Our amygdala responds to the word budget in the same way it responds to the word diet — with utter dread.
Budgeting, like dieting, is disliked because it requires determination. It requires us to be disciplined with our spending habits. It forces us to think twice about spending and adopt the mentality of penny-pinching. It often requires a change in habits.
But let’s face it, the world revolves around budgeting. Everyone from the federal government to your 12-year-old niece saving for her first mobile phone are on a budget. In fact, three in four Australians regularly maintain a personal budget.
Unfortunately, this enthusiasm for money management doesn’t translate to the business world. My best estimate, based on my experience, is that less than five per cent of Australian SMEs maintain a business budget. This is a detriment to business outcomes, and perhaps the main reason why a lot of businesses fail.
Here’s what’s involved in setting a financial budget for your business, and how it can help you to make decisions for the future.
In this article:
What is a budget?
A budget is a financial plan for your business. It’s a tool that is used to quantify an organisation’s business strategy over a set time period. A budget is typically built for a 12 month period, and it’s designed by your accountant or CFO.
The process of building a business budget entails the following:
- Developing estimates of future sales and cashflow
- Developing estimates of future expenses
- Developing estimates of capital expenditure and financing arrangements
- Summarising these estimates into a projected profit-and-loss, a balance sheet and a cashflow statement. This process is referred to as a three-way budget.
It’s important to note that your budget is a living, breathing document. It is not a spreadsheet that is dumped in the archive folder, ready to be revived when your bank or VC requires it.
Rather, a budget should be reviewed every month, and actual performance should be compared against the current month’s budget. This analysis allows your management team to measure progress against the organisation’s goals. This assessment guides management’s actions for the future.
A three-way financial budget
At the risk of inflicting death by spreadsheets, a three-way budget is a jam-packed document filled with forecasted financials about your business.
The outputs – your budgeted profit-and-loss, balance sheet and cash flow statement – are built off a set of assumptions tailored to your business. We include known expenses such as your employees, your capital expenditure, and all of your fixed operating costs.
From a revenue perspective, we do deep analysis into the products you sell, the average gross profit margins, and even forecasting your inventory.
We use all of the assumptions of your business to build your financial plan that becomes the blueprint for your business for at least the next 12 months. This allows management to predict the future, set targets and work towards a goal. Importantly, it helps you to look forward and plan for the future of your business.
Why have a financial budget for your business?
There are a range of benefits that come with maintaining a financial budget.
1) Quantify what is and isn’t working
The process of comparing actual results against a budget allows your management team to assess how the organisation is tracking compared to its goals. It can act as a data point to address what tactics are working, what isn’t working and what should be tweaked.
2) Predict the future
A well prepared and thought-out budget can help to predict future financial performance. By assessing projected sales, expenses and cashflow, it allows management to make proactive decisions. For example, if budgeted sales are expected to be lean due to the holiday season, financing facilities can be pre-approved to fund any working capital shortfalls.
3) Align management to organisational goals
Keeping staff and management aligned to the goals of the organisation is hard to do without a pace car. A budget can provide the set of quantifiable targets they can strive towards. Simply put, it’s an accountability tool.
4) Understanding the business drivers
Beyond visibility, the value of developing a budget is in the process. It will help your management team understand what drives your business. For example, revenue should be broken down to number of leads, average sale value and conversion rate.
To create discipline within our business, we must focus on the process, rather than the end goal. Focus on the ritual of being accountable to the budget framework and make tweaks as we go — rather than leaving it to a mad sprint to the finish line.
A budget is an antidote to our impulsive, often emotionally charged decisions. It’s a tool to keep us disciplined and focused on our long-term strategic goals.
Just like your 12-year-old niece has her heart set on buying a phone, you can achieve your business goals with a thorough financial budget.
So, if you’re interested in setting financial accountability in your business, send me a DM. We’re here to help.