Many owners of SME’s question the need to prepare a budget. They’ll make excuses like “We’re not big enough to need a budget”, or “we don’t need a budget – we know our business well, and can feel when we’re on track”. Ultimately this leads to “In any event, it’s too hard.” They just don’t see it as a necessary management tool.
Is A Budget Really Necessary?
Most business owners accept the need to have a business plan. They accept that, just as a builder needs a plan to build a house, the business owner needs a plan to build a business. There must be a vision, to articulate where the business should go, a mission to articulate why the business is being built, and the owner needs to identify what must be done, and what hurdles must be overcome, in order to achieve the vision.
But an essential part of any plan is the financial element. The builder has a bill of quantity, and an estimator, in order to determine the price they will charge. In the same way, for the business plan to be complete, it needs the financial element– and that financial element is the budget.
If you are to manage something, you need first to measure it. A business owner must manage the finances, as a failure to do so can result in bankruptcy. So every business owner must measure the finances. That means that the owner must have an informed examination of the profit and loss account, and the cash flow statement every month – and that is just the first hurdle to overcome.
What Will A Budget Tell Us?
But even if that is achieved (and it is a sad fact that it is honoured more in the breach than in the observance), it is not enough. Looking at the financial reports in isolation can be meaningless. Are the results good or bad? Are we happy to go on the road we’re on, or do we need to make adjustments?
These questions cannot be answered, and the financials will not be meaningful, until they are compared to the expected position. And the only way to do this is to compare the financial position on a monthly basis to the plan – and that means the budget.
It is only then that the owner will know whether the business is on track to meet the plan, or if corrective action needs to be taken to ensure that goals will be met.
If there is no budget, there is no way of knowing if the business is travelling well, or is headed for, at best, disappointment.
A budget is an essential part of the owner’s toolkit in the management of the business, and in the achievement of the overall business plan.
Preparing A Budget
So, how do you prepare a budget? How do you get it out of the “too hard basket”, and make it a reality?
There are, basically, two ways to prepare a budget – based on previous years, or “zero based”.
If you base your budget on previous years, you take the previous years’ performance, and add on a percentage growth that you think is applicable for the coming year. The expenses are looked at intelligently – for example, the rent will be governed by the lease, not by an arbitrary growth factor. This is not a difficult process, and a budget can easily be prepared. The growth rate chosen can be set to stretch the business, and make it a challenge, while still being achievable.
Zero-based budgeting is more difficult. This entails looking at the state of the market, the competition, the vision, the 5-year plan, the marketing plan, and all the other factors that affect the business. The budget is then constructed without reference to previous years, and will result in a logical plan that can be explained. A zero-based budget could, in some cases, reflect a result lower than in previous years.
Whichever model is chosen, it is essential that a budget be prepared. If a zero-based budget appears too formidable a task, use the other model.
If you would like assistance to create your budget, contact us. We have spreadsheets to assist in the preparation of budgets based on previous years, and we can also assist you to create a zero-based budget. We are passionate about the need for every business to have a budget against which to compare your actual figures, so that you know whether or not you’re on track to get the results that you want.