Annual budgets can be a key financial management tool. Here is how to use them to help maximize the profit for your company.
Business people typically like to set goals and strive to achieve them, but they may be hesitant around making an annual budget.
Three general hesitations around setting up an annual budget may be:
1. Business owners might not know how to project what will happen in the future.
2. They may fear seeing projections that show them losing money for the year.
3. They may worry about being able to meet their budget during the year.
But an annual budget can be a helpful financial management tool. Setting one up can help increase profitability, and help ensure there is enough capital to run the company each year. Here is where to start:
1. Collect your numbers to create an annual budget
You can start your annual budget by reviewing the annual profit and loss statements from the last two years. Take out one-time revenue and expense bumps that will not be repeated in the current year.
Business owners may project revenue to be too high and expenses to be too low. When in doubt, consider cutting revenue expectations by 25 percent and increasing expenses by 10 percent.
You can use the information left to calculate the average of these last two years. Adjust the numbers for current year increased expenses, changes in gross margins, market conditions, one-time investments and projected revenue. Review each account category in your annual budget in detail and consider how they relate to each other. For example, will more salespeople result in higher income? Will more employees increase the company’s health insurance expenses?
Some fixed costs may not change with revenue (e.g. rent), but others will (e.g. sales commissions). If this is the first time you’re setting up a budget, Microsoft Excel has templates that can be utilized.
2. Replace optimism with realism.
Annual budgets become ineffective if they are filled with only hope without a realistic chance of meeting those projections.
Think through profit goals and why certain numbers are set the way they are. For example, what expense investments are being made this year that sales will increase? If the cost of goods is expected to go down, then why?
Business owners may project revenue to be too high and expenses to be too low. When in doubt, consider cutting revenue expectations by 25 percent and increasing expenses by 10 percent. You may want to ask an accountant or banker to review the budget and raise additional questions to be considered.
3. Add the annual budget into your financial system.
If you take your annual budget and divide it by month, it can become a pro forma profit and loss statement for the upcoming year.
You can enter it into the company financial application. This way each time monthly financial statements are reviewed, they can be compared to this budget.
4. Adjust once a year.
Annual budgets work better when they are utilized correctly. They can be a way to track planned monthly revenues and expenses against actual performance, and can help answer the question: “How is the company doing compared to what we expected?”
Ideally budgets should only be set once a year, and then changed only every six months. It may make business owners feel better to adjust the budget to meet lower performance, but it does not help manage the company.
Try not to hastily pass judgement on being financially ahead or behind on the budget forecast. Treat any unexpected result as valuable information that the company can use to make mid-year adjustments. If after six months, the company is more than 50 percent ahead or behind the budget, then the annual budget may need to be recalculated, so it can still be a valuable financial management tool.
5. Control and tune the annual budget.
If the company is not meeting the budget, consider which expenses can be controlled or reallocated. What changes need to be made to hit revenue targets? Asking these types of questions is the exact purpose of the budget. It can help companies make adjustments that still allow them to meet their goals.
How do you set a budget for your company and what have the results been?
Author: Barry Moltz
Getting Small Businesses Unstuck, Shafran Moltz Group