As a business owner, you may already know that running a business is no small task. It requires a lot of work, good help, and proper planning to just stay afloat, not to mention scale up and move forward!
One of the key components in determining business success is the ability to create and follow a budget.
Not just any budget will do. Business budgeting differs quite a bit from personal budgeting options. You must create a strategically designed budget that suits the specific needs of your business.
That being said, a strong foundation of general budget guidelines should be established before adding those ‘specific’ budget requirements that your business will require during the upcoming year (2020).
Your Budget Supports Your Business Plan
With so many factors influencing the success or failure of a business, advanced budgeting is a must for any company that wishes to meet the challenges of foreseen and unforeseen circumstances that may appear during the fiscal year.
Budgeting can help businesses:
- anticipate cash inflow and outflow
- identify financial needs and requirements
- meet tax obligations
- gauge business performance
- explore and uncover new business opportunities
All these factors are important to keeping a company alive and healthy, especially if it is just starting.
50% of small businesses fail within their first five years!
Since budgeting is so important, how should a business owner along with the rest of the management master it?
The specifics of budget planning will come down to the requirements of every single business.
Of course, there are general guidelines that business owners can follow to help push their budget planning process in the right direction.
Primary Objective: Goals and Risks
Budgeting is based on predictions—about what will come in the future based on what happened in the past.
In this case, you must predict how much capital you will need to spend and where it should be allocated during the 2020 fiscal year.
This prediction must be based on what you have spent during the 2019 fiscal year.
Since past results are being used to predict future possibilities, two things should be established before you begin with an advanced budgeting process: business goals and assessing risk.
Without setting goals for your budgeting, all you are doing is keeping track of your income and expenses.
While this is important for any business, all the other benefits like projecting profits, securing loans, attracting investors, spotting potential problems, and maintaining financial stability will not be achieved.
Roughly 80% of small businesses fail to set goals and 77% of them fail to achieve their company vision.
The main point of aligning the budget process with company goals is to set the stage for the entire budgeting process—to give it a sense of direction per the company’s vision!
How should this be done?
You must identify upcoming financial scenarios based on past scenarios and assess their impact on achieving the company’s goals for the upcoming year.
A certain amount of risk is always involved anytime future predictions are made from past results. What happens then, if the budgeting is off?
In other words, what if a company overbudgets or underbudgets?
- Overbudgeting: Capital goes uninvested, which means no money is being made of the money previously earned.
- Underbudgeting: Can lead to unexpected cuts and delayed opportunities and cash inflows.
To limit the possibility of overbudgeting and underbudgeting, you should connect risk management with your budget planning.
Implementing Risk Management
The easiest way to deal with risk is to hire a risk management expert to help you define and uncover potential future risks and budget for them accordingly.
If this is not possible, then use your insights, as well as the insights of your management team and key staff members to create future risk assumptions.
Your risk assumptions will be based on the likelihood of past financial occurrence happening again and how they can affect your business in both a positive and negative light.
The ultimate goal of incorporating company goals and risk management into your budget plan is to create more predictable financial forecasts.
That way, your business can maintain its competitive advantage, increase its market value, and produce better products and services.
Tips for Successful Budgeting in 2020
Once your 2020 goals are set and your entire team (e.g. managers and employees) are aware of the potential risks involved in budgeting, it is time to move onto the process itself.
It would be wise to arm yourself with a set of proven guidelines that will increase the accuracy of your budgeting forecasts and keep your business running during emergencies and unforeseen events.
The following five advanced budgeting tips have been given so that you don’t get lost in ‘mindless speculation’ based on factors outside of your control (i.e., Fed rate cuts, global economic conditions, etc…) and instead focus on strategic budget planning that is based on high-probability business outcomes that your company can control and manipulate to a large degree.
Tip 1: Pessimistic Income and Cost Projections
As there is no way of predicting the accuracy of any future financial projection before it happens, it is always good practice to be more pessimistic in how much money your company will bring in as well as how much money it will cost to run your company in the future.
Your future income streams and costs will set the stage for all your other budget calculations and assumptions so it is better to err on the negative than on the positive.
According to the Urban Institute, a Washington, D.C. economic-based think tank, budget forecasts are almost always wrong and by a large margin!
Exaggerated and even mildly optimistic income predictions will make the budget planning process easier but will also increase the likelihood of potential setbacks and downtime.
The following brief list showcases some of the possible scenarios brought about by overly-optimistic cash inflows:
- Not being able to meet operational costs
- Missing out on potential business opportunities
- Losing control over capital allocation
The same goes for underestimating next year’s potential cost of business. You should always assume that next year’s cost of doing business will be a little bit more than last year’s because most likely it will be.
71% of small businesses experience a rise in operating costs almost every year according to a recent Federation of Small Business (FSB).
Think of it this way, it is better to have a little bit more money sitting in an emergency fund than having no money in the bank when an emergency hits.
Tip 2: Reduce Fixed Costs
Tying up capital in long-term fixed costs can reduce your expenses in the long run but will also reduce the flexibility of your budget.
Remember, when budgeting for the future, being more pessimistic is a safer bet than being too optimistic.
One way to improve your budgeting forecasts is to reduce some of your long-term fixed costs.
Many business resources like subscription software solutions (management software, customer relationship software, security software…) offer tremendous discounts when signing up for a long-term deal.
These discounts can boost profitability as they cut down on business expenses, however, they also limit the ability to scale down when needed.
For example, what if you decided to enter into a long-term commercial lease next year but as the year progressed revenue slowed down and the savings you thought you were gaining from the multi-year deal turned out to be additional costs that put your business in jeopardy.
Instead, had you taken in the ‘bigger picture’ during your budgeting process, namely that your business was only two-years-old, you might have decided to lease a co-working space until your revenue and profitability numbers were a bit more seasoned.
Tip 3: Budget for Taxes
This may seem self-evident but you would be amazed at how many businesses do not consider taxes when creating their budgets.
It is not that business owners don’t realize that they have to pay taxes but mostly it is that they do not know how much to set aside to pay them.
Either 20% of your gross revenue or 35% of your net revenue should be placed in a separate bank account whose sole purpose is to pay business-related taxes.
If you do not budget for this recurring expense, you will increase the following risks:
- Late penalties and fees
- Seizures and tax liens
- Criminal charges
Budgeting for taxes means putting aside the amount needed to pay your estimated business taxes so you don’t incur additional costs in the form of money, time, and even business seizure and closure!
Again, as with all the other budgeting forecasts, it is better to be safe than sorry, thus the 20-35% revenue numbers.
Tip 4: Set Aside Money For Emergencies
Budgeting for what you can control in your business is ‘smart’ budgeting but so is budgeting for those things that are not in your control.
Can you even budget for unforeseen events and things you can not predict?
Yes, you can.
Set aside some cash in an emergency fund for those random and unpredictable occurrences that appear in the life-cycle of every business at some point.
The money in the fund will help to pay for the following uncontrollable and unpredictable events:
- Reduced consumer spending
- Economic downturns
- Natural disasters
- Tax increases
- Cyber attacks/Cybercrimes
How much should be saved within the emergency fund?
Anywhere between 3 months to a year’s worth of expenses should be set aside for emergencies.
The actual number will, of course, depend on your predictable business expenses and income streams plus a little extra for those unexpected and unpredictable costs that always seem to surface in your business every year.
When figuring out the exact time frame more is almost always better but the minimum amount should equal 3-month’s worth of expenses.
Tip 5: Apply the 50/30/20 Rule
The 50/30/20 Rule is mostly used in personal budgeting but it can work just as well for business budgets.
The gist of the rule is as follows:
- Limit needs to 50% of after-tax income
- Limit wants to 30% of after-tax income
- Use 20% of after-tax income on savings and debt
To get a better understanding of what business needs are, here is a brief definition: A business’s needs are what it ‘must’ have to propel its current state to its future goals.
In essence, the needs of a business are all those things that are required for it to run properly and continue to grow steadily. This most often includes employees, projects, and inventory.
Business wants, on the other hand, are those things that would be nice to have but are not required to make the business run more efficiently and effectively.
- Aesthetic office surroundings
- More vacation time for employees
- Additional marketing and advertising budget
As for savings and debt, this could be split halfway:
- 10% gets put away into your business’s emergency fund
- 10% gets spent paying off the company’s short-term and long-term debt
The percentages do not have to align up as accurately as mentioned above if they cause difficulties for your business.
Work the numbers out according to your business requirements but continue to use this three-part budgeting split between needs, wants, and savings to make sure your business is not spending more than it earns.
Failing to Plan Means Planning to Fail
Failing to budget is a sure way to get your business in trouble.
If you have no idea of what next year’s potential income streams, costs, and risks may be, how can you set security measures to deal with downturns in revenue and upturns in expenses?
Business budgeting is a skill that gets better with time. As your business matures, so will the predictability of your revenue and costs.
The goal of budgeting is to make sure that a business has enough money to keep it running and growing.
Use the five advanced budgeting tips listed above to help you make sure that your business has enough money to meet next year’s requirements and challenges!