Remarkably few independent operators take the time to properly build a financial budget. When asked how a business is performing, I often get vague answers. “We're doing pretty well” or “I think we should be putting more on the bottom line” are common. If you don't set operating targets and, most importantly, measure your actual results against those targets, you're flying in the dark with no instruments.
A business needs targets and objective data to measure progress. It reveals where work needs to be done. Without it, you fall into the trap of making emotion-based decisions with little understanding of the potential outcome.
Why do you Need to Budget?
A budget is necessary if you intend to:
• Challenge the business to perform and deliver your required bottom line.
• Identify key areas of improvement where you and your team must act urgently.
• Demonstrate to banks and potential investors that you run a solid business.
• Seek alignment with your team on financial objectives. Your key people must know how the business is performing and what their role is in reaching targets.
When/How Often do you Need to Budget?
Your annual budget should be completed, at minimum, one month prior to the start of your fiscal year. The budget maps out each month/financial period line-by-line and totals your expected budget both quarterly and for your year-end. The annual budget helps you plan your spending and allows you to focus on controlling key expenditures.
At the end of each quarter, you can enter your actual results in place of the budgeted amount for the period and allow for a solid forecast of where your year will land. This is commonly referred to as a 3 + 9, 6 + 6, and 9 + 3 budget. 3 months actual + 9-month forecast; 6 months actual + 6-month forecast… you get the picture. It reveals where you will end up.
These times call for putting your original budget on the back burner and moving to quarterly budgeting. New businesses should do this as well. This way, your numbers have relevance to your team. The landscape is uncertain and while many principles remain, you need to shorten the time horizon and be willing to adjust.
What is a Budget Based On?
Where do the numbers come from? Budgeting is based upon both data and assumptions:
• Actual historical performance. This is a guideline; you do not necessarily want history to repeat itself, but it's a good place to start
• External economic trends
• Industry standards
• Your annual plan outlining your intention and objectives for the fiscal year
• What ownership needs from the business – profit first. This is where you define what the business must put on the bottom line by the end of the year
Write. A. Budget. Write. A. Budget. Write. A. Budget. Write. A. Budget.
If you want to prosper, write the budget. Don’t be afraid of the process or give in to feeling overwhelmed. Yes, the notion of a budget can stir up a lot of feelings. I get it!
A budget is a tool and a financial roadmap. Don’t get bogged down in seeking perfection. The more you budget, the easier and more accurate the process becomes. It's not complicated. It helps you to see the state of your business objectively. This clarity empowers you to work on your business at a high level—plus, it's strangely gratifying.
This process will clarify where you need to work, as well as where you're killing it. Time well spent!
Until next time.