What is a budget, why should I bother?business_link

My accountant and my bank manager have suggested that I should have a budget for my business. I am not sure in practical terms what this means, but it does sound like more useless paperwork. So tell me please, what is a budget and why should I bother - I always end up making a profit and my accounts go in on time?

Last month we looked at what budgeting is and some of the terminology used. This month we will look at the rules for putting together a simple cash budget, some thoughts on extracting the important things to review regularly and then look at what to do once you have reviewed them.

Discuss what would be the best budget format for your business with your accountant or business adviser. In the meantime what follows will hopefully help and encourage you to set up a basic budget and financial management process to get you started.
Although the table below is simplified for this article, the principles and the rules are the same as those for more detailed budget formats.

 

  May June
Cash in:    
Cash Sales 500 600
Credit Sales 500 600
Total Inflows: 1000 1200
Cash Out:    
Purchases 300 400
Wages 200 200
Rent 50 50
Etc 50 50
Total Outflows: 600 700
Net Cash in / out 400 500
Opening Cash 600 1000
Closing Cash 1000 1500

budgeting example

Some golden rules:

Cash in and out of the business is entered in the month that money leaves the bank or is deposited in the bank and cleared. The whole point is to estimate how much cash you expect to have at the end of each month. This of course can be several weeks after you raise an invoice (in the case of credit sales) or receive a bill.

Always include VAT, in a cash budget because whilst you will have to pay HM Revenue and Customs when it is due, it will be in the bank until then. You must of course include the VAT you are likely to owe (or be refunded) on the forecast so that you can plan ahead.

Be sure to include all expenses and incomes in the budget, for instance you might plan to sell a surplus machine for £200 in May having paid £5000 for a new one in April. These are unusual transactions but they still affect the bank balance.

“But what about the money that is already in the bank?”

The opening cash in table above the is what you expect to have in the bank on the first day of the month and the closing cash at the end of this month is the opening cash for the next month - if you follow my drift.

“It's impossible to predict sales and therefore how can you have a realistic cash budget?”

But that misses the point! A new business with no sales history can accurately forecast the overhead costs which will then allow you to work out the level of sales (not forgetting stock purchases) that you will need in order to stay in the black. For an existing business, start with monthly sales for last year and add back or deduct anything that is unlikely to be repeated this year i.e. a very large one-off sales invoice paid in or any other one off events effecting cashflow. Then further adjust the figure to take into consideration what you expect to happen this year including price inflation.

“At last I've finished the forecast so I can stick it in the draw and forget about it”.

Oh no you can't; the major purpose of a budget is to monitor your actual results against what you expected and then ask 'why' if there is a difference. This means producing monthly results to compare against the budget. Some business may get away with quarterly reviews, but for most this is too long a time frame. The benefit of monthly is if sales or controllable costs vary significantly then you can decide what you need to do to improve things very quickly, whereas by reviewing less frequently it may be too late or take much longer to turn around. You can adjust the budget up or down as trends and new information emerges to reflect the situation, but don't lose sight of where you want the business to be.

“Should I compare every cost or income?”

No, there are some things that are out of your control i.e. rent and rates, and some are so small as to not warrant it. But you should identify the important things (sometimes called key performance indicators) to measure, and in terms of the cash budget this would normally include sales - possibly broken down into major categories, gross margin and some of the bigger variable costs like staff overtime and energy (although this may need to be done quarterly). You can always investigate major differences in the remaining overhead costs if there appears to be an unexplained overspend.

The important thing is to take action, to do something about the variances - that is what management is all about, and the management of your money is the key to survival and success.

As a business adviser I have met with many failing businesses, many of them were intrinsically profitable but had run out of cash with which to pay their debts, and usually in these cases there is not even a basic financial budget & management process in place.

That's all for this month.

Peter Mulhall
Business Adviser
tel: 07717 290309

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