In business, you keep hearing the word ‘budgeting’ and it really sounds so wonderful to think that with a little planning all your finances will be smooth-sailing. Prioritise, allocate, and done! Theoretically speaking, true. But in truth, making a budget isn’t as simple as you would like to imagine. It is a crucial part of the success of any business and must be done thoroughly, without quick-fixing nor by taking short-cuts. So, here are some fundamentals to help you understand budgeting so that you can have a meaningful conversation with your finance department.
- Budgeting: Every company needs financial goals to manage their money. Budgets help them strategize – into which tasks, short and long term goals, or potential emergencies should the money go. When you budget, you lay a road map to financial goals, prioritise what projects will need more money and where you have to restrict it, and overall manage money in a way that you can achieve as much as possible in the business. Budgets can be done annually, half-yearly or quarterly, depending on the changes you want to make based on the results of the company.
- Reasons to budget:
- To appropriate funds suitably to cover all your bases in the business.
- To strategize long-term revenue goals and thereby the necessary short-term goals to achieve them.
- To ensure you don’t spend where you can’t or when you shouldn’t.
- To have a buffer when business is lean, or to have a little extra to invest in unexpected opportunities.
- To understand the available resources and allocated them sensibly to each department for growth and development.
- Exceeding the budget: This does happen to the best of us. Unexpected costs arise, and it isn’t possible to always anticipate them beforehand. Sometimes it could be a simple case of just having to spend more on something you expected to cost less. What you can anticipate, however, is to have unexpected costs arise and to have a backup for such times. Either look to external fund sources or have an emergency fund to help you get through.
- Foreseeing situations for the budget: Part of budgeting is to incorporate various possible scenarios into the budget, and ensuring the budget is flexible enough to be revised if necessary. The budget has to take into consideration all department operations. So by talking to the heads of each department, you can understand where there are holes in the budget, and how to make estimates for the future. Certain standard things that you need to consider are future investments in inventory, equipment, infrastructure, technology, R&D, marketing and sales etc. Then you need to think of the contingency budget and debt management plans. Basically anything that affects the bottom line.
- Contingency budgets: A contingency budget is like an emergency budget. You put away some money for bad times. It protects you from incurring losses because of unforeseen business emergencies. This budget can be planned based on an analysis of risk and probability.
- Doing it on your own vs. getting a professional to do it: It may be alright for you to use software to plan the basics of your budget. It may even work if your business is very small. However, you need a proper financial expert to oversee the planning and customising of the actual budget. Ideally this task falls to the CFO, or an external advisor (if you can’t pay for a CFO just yet). Apps and budget software can be used effectively to track money spent or money coming in, and to organise and automate that bit of accounting to aid in financial management. However, an experienced financial professional understands KPIs (key performance indicators), has the experience to create accurate financial forecasts, and will be able to streamline the process and prepare you for questions from investors (an important aspect for start-ups).
- KPIs to consider when budgeting: KPIs are performance measurements that help you make smart business decisions. For companies, financial performance indicators help you plan smaller details that aid in the bigger picture when budgeting. The common ones used are cash flow, sales and marketing endeavours, payroll expenses, return on equity, AR & AP, burn rate, and turnover rate.
As you can see, budgeting is imperative to the success of your business and directly impacts your bottom line. Having a basic understanding about it helps you ask the right questions when making the budget and helps your CFO tie in your business plans with your finances.