If you wanted to invest in the stock market, you’d probably do some research on the company that you’re interested in, right? You’d want to know the answers to questions like: is the company making a profit? Is revenue increasing? Is it in a position to repay its debts? Basically, you’d want to examine the company’s financial statements to gain an insight into its future performance; as this would help determine whether it’s worth investing in.
Similarly, if you’re looking for an investor to inject money into your business, or you need a bank loan, you can be sure they’ll ask to see your financial statements. They’ll want to know how you are performing financially and whether you’ll be good for debt repayment. I recently worked with a client who needed to secure a bank loan, but they’d never maintained a budget. There’s no way the bank would consider this application, so I worked with the client to develop a robust financial reporting system. These reports gave the bank the insight it needed into the business’s future revenue and cash forecasts, and thus the confidence to offer a loan.
So what is a budget?
Put simply, a budget is an estimate of the expected revenue; expenses and cashflow of your business operations for a given period – usually the next 12 months. Monitoring your budget regularly against actual results, lets you know whether or not you’re on track to meet your financial goals.
Why do you need a budget?
- Okay, so the main reason for maintaining a budget is to avoid running out of money, which is the biggest risk for any start-up.
- It will help you develop your cashflow forecast, which is crucial for every business (remember – cash is king). By adding income and expenses into your budget, you’ll know how much you need each month to build a profitable business.
- It can help you secure finance. Investors and lenders usually require a business to provide an annual budget, as it indicates your financial viability and whether you’ll have the capacity to pay the loan back.
- Tracking actual results against a budget lets you identify any problem areas and make the right decisions for adjustments.
Key points to consider when preparing a budget
- Business strategy – what are your plans for growth and do your budgeted expenses reflect what it will cost to expand?
- Abnormal items – do you envisage any large costs in the future: a large project, additional staff, new equipment etc? Again, this needs to be reflected in your budgeted expenses.
- Prior year trends – this will give you an indication of future revenue and expenses.
- Cashflow requirements – you need to understand how much money will be coming in to the business each month (customer payments, interest earnings etc) and how much will be going out (supplier payments, wages, loan repayments etc) as it will help you understand how much money you’ll have left over, and therefore how viable your business is.
- Industry/market conditions – you need to make some assumptions about your industry to keep your business relevant. Will the market shrink or expand? Is the number of competitors changing? If you’re a bricks and mortar business, do you consider moving online? Other technological advancements you need to think about?
So what can a budget tell you?
- Revenue not meeting forecasts? An obvious answer is a reduction in sales, but less obviously, you may not be invoicing regularly enough. Having an effective accounting system makes the invoicing process swift and simple.
- Are you charging enough? Don’t make the (common) mistake of failing to cover all fixed costs (rent, salaries, overheads etc) as well as operating costs when pricing your product.
- Are receivables lagging? By monitoring cashflow, you can identify which customers are not paying on time. A quick phone call can fix the situation and help keep your cashflow positive.
- Are you spending too much? If your expenses start to exceed the budgeted figures, you can identify the problem areas and make the necessary decisions to cut expenditure.
- Do you know exactly what you owe? If you aren’t tracking all expenses accurately – including which ones have and haven’t been paid – you may unexpectedly find that you owe a lot of money – which you can’t pay.
Predicting the financial future of a start-up can be challenging. Your initial estimates won’t be accurate, but after a period of continuous tracking and adjusting, you will start to make more accurate forecasts.
A budget is a must if your business is to have any chance of survival. It’s the means to reaching the financial goals you’ve set, and it provides the insight to how you should be making future decisions to help your business succeed.