Budgets are an excellent tool to help manage a business; however, poor budgeting practices can result in a loss of functionality and power as soon as the budget is prepared.
Too often we see small and medium sized businesses prepare budgets as a "set and forget" task on a yearly basis, or as part of an initial business plan when starting a new venture. Often these budgets are prepared as a standalone item in Microsoft Excel or Google Sheets, and are not connected to the accounting or financial reporting system of the business. These are what we consider poor budgeting practices.
So what does good budgeting practices look like AND what value can it add to a business?
A budget should include integrated 3-way financials - that is, profit or loss, balance sheet and cash flow.
A budget should not just be a profit or loss. The inclusion of a budgeted balance sheet and budgeted cash flow statement that are integrated (linked) to each other and the profit or loss is key.
Without 3-way budgeted financials, a business will not understand how the budgeted profit or loss or budgeted capital expenditure will impact its cash flow in say 6 months' time or how it may impact any banking covenants the business has. Cash flow is and always will be king in determining the success or failure of a business.
Furthermore, 3-way budgeted financials help highlight where deficiencies might exist in the business e.g. a poor cash flow cycle should be evident when reviewing budgeted operating profit against budgeted operating cash flow.
A budget should allow for easy monitoring of actual results vs. budget.
A business needs to be able to review and analyse actual vs. budget (primarily the profit or loss and cash flow statement) without needing to export actual results from the Accounting system.
Further, by building the budgeted profit or loss down to each individual ledger account, but then also grouping revenue and expenses from the Chart of Accounts into appropriate categories (e.g. occupancy expenses), a business is able to assess variances at a category level (which is often easier for identifying issues when there is a large number of ledger accounts in use) or at an individual account level.
A budget should provide a means to assess performance of the business against key value drivers.
The key here is to build the budget using value drivers where possible e.g. average monthly value per customer, number of new customers obtained per month etc.
If the budget is prepared using meaningful value drivers for the relevant business, then it will be much easier to ascertain the reasons for the variance in performance (whether out-performance or under-performance) by looking at actual results for those value drivers against budget.
A budget should allow a business to review the expected full-year result and expected cash flow position at any given time.
A business needs to be able to easily view actual results for year-to-date + budget for the remainder of the year.
If the actual performance is materially different to budget for year to date, it will likely mean that the original cash flow budget will no longer hold much relevance. However, by having the ability to automatically pick-up the actual cash flow position based on results to date and combine that with budgeted cash flow for the remainder of the year, the budget retains it functionality / usefulness.
Further, the ability to take the budget for the remainder or the year at any point in time and easily adjust it based on learnings from actual performance to date, to create what is called a 'forecast', unlocks even greater power for a business.
A budget should allow a business to add-in scenarios to assess the expected impact of initiatives that are being considered.
These initiatives may relate to new business (products, services etc.), capital expenditure projects (new equipment, premises fit-out etc.), or business efficiency (such as initiatives to shorten the cash flow cycle).
The key here to extract most value is to not over-complicate the scenarios e.g. budget for the impact of new advertising costs on revenue, but don’t over-complicate this scenario by introducing other unrelated costs or revenue.
A budget should allow a business to confidently approach potential financiers or equity investors.
A robust and dependable budget is necessary if a business or its owners are looking to obtain finance for growth or working capital purposes, or are looking to divest the business.
Most investors who are considering financing the business would be seeking not only 3-way budgeted financials for a period of 3 to 5 years, but also a budget pack detailing the key assumptions and highlighting any significant initiatives or risks to achievement of the budget.
How does a business go about achieving the above and unlocking the power of good budgeting practices?
A great starting point is to make use of a software product that:
Integrates with your accounting system;
Has a functional, robust budgeting or forecasting tool; and
Allows you to not only prepare the budget, but also easily create a budget pack showing summary budgeted financials; forecast revenue, expenses, earnings and cash flow in a visual way; and key assumptions used in the budget.
Second, it is worth utilising the skill set of an expert in budgeting. The role of this expert is to work with the Management Team to understand the key value drivers for the business, and then build a robust budget based on these value drivers.
At Zealth Advisory, we utilise a software product called Fathom (Reporting, Analysis and Forecasting software) for our clients to prepare robust, 3-way budgeted financials and budget packs, and unlock the benefits of good budgeting practices as set out above. We have extensive experience in budgeting and forecasting and across various industries, and have built many budgets for both business planning / strategy purposes, and financing or divestment purposes.
Get in touch to see how Zealth Advisory could unlock the power of good budgeting practices for your business.
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