It’s that time of the year when many companies are busy preparing budgets and forecasts. At the same time the most recent turmoil around UK government mini-budget (Mini-Budget) demonstrated how important budgets and budgeting process can be. Yet, SME owners and directors often underestimate the importance of budgets. According to survey by Clutch around half of SMEs do not have a budget. Those SME's that do, usually prepare it just because its required for fund raising and they do not use or update it regularly to control their business. In my view, these businesses are missing out a great deal.
Why Do Small Businesses Need a Budget
It is common to think that small businesses do not need a budge. Nothing can be further from the truth. Most SMEs lack access to financing opportunities compared to larger businesses and are more vulnerable to changes in the market, making a budgeting process more necessary, not less.
Budgeting process allows for an accurate forecast so that your business can avoid unpleasant surprises. When your business has a budget, you have the information that you need to make better business decisions and work towards your business goals.
SME owners and directors need a budget to:
Look ahead - How much profit can I expect? Will I be able to meet all the payment obligations next month if all goes as expected? Can I purchase new equipment in 6 months? Its only possible to answer such questions accurately when there is a budget in place.
Keep finger on the pulse of your business - it is impossible to know whether your business is doing well, if there are no set up goals. Budgeting process is the best way to collect, align and prioritise all the gaols from different teams in your business. What gets measured, gets done. Comparing budgeted figures with actual results will allow you to have a better understanding of your business, identify and solve the problems quickly and evaluate the performance of different teams.
Make informed decisions - Doing these things without a budget could mean that every day decisions are made based on instinct or guesses, with no check with reality. Mini Budget is a good example of how making both financial and strategic decisions without the right financial information can lead to disaster.
What Should Be Included in the Budget?
Your Budget should be broken down in months (or weeks), extended to at least 1 year and include:
Information about the key assumptions - A budget without assumptions is like IKEA furniture with no assembly instructions. If management team expects 10% growth in sales, and have used this assumption to forecast the sales figures, it needs to be included in key assumptions sheet. The same is true for all material income and expenses, as well as balances and movements.
Profit & Loss Statement (P&L) – this is summary of business revenues and costs for the specific period.
Balance Sheet - a statement of the assets, liabilities, and capital of a business at a particular point in time. Key items included in the balances sheet are fixed assets (such as vehicles and computers), stock, receivables from customers, payables to suppliers etc. It is impossible to forecast the future of the business without forecasting these items. Unfortunately, many SMEs do not produce a balance sheet statement as part of their standard budgeting and reporting process. Those businesses are missing out because they won’t have all necessary information to run the business.
Cash Flow – Can I pay supplier invoices and taxes in 3 months’ time? Will the business have enough cash to invest in a new, electrical van in preparation for the peak season? Are we running out of cash at any point during the year? It's impossible to answer these questions without a cash flow forecast.
Other Important Considerations
Budgeting is a Team Effort - The budgeting process should be carried out together with other departments and teams. The key here is the collaboration of the finance team who creates the budget with all other teams in the company. This ensures their buy-in and commitment to final budget figures so that the budget is applied accurately across the company and followed throughout the year. An annual budget isn't something that can exist independently. It needs to be developed with key managers and stakeholders on board so that the whole company understands the business's financial outlook.
Budgets Should Be Flexible: Five years ago, budgeting used to be a yearly exercise, but this is not the case anymore. Preparing an annual budget is just the first step, and budgeting should be a continues process. Changes are so rapid, that it is not possible to rely on a forecast made month ago. Many businesses therefore have moved to flexible budgeting, where the budget and key assumptions gets evaluated at least quarterly, or every time managements accounts for the period as finalised. This allows business directors to timely adjust their plans and take necessary actions when needed.
Zero-based budgets: Zero-based budgeting simply means justifying expenses for each accounting period, rather than basing it on the past spending. An IT service provider I advise, started using outside contractors couple of years back, overpaying 3:1 compared to in house costs. This was identified during zero-based budgeting process, saving a company around £50k per anum.
The Resource Problem
Many SME’s trust bookkeepers instead of qualified finance professionals to prepare their budgeting and management reporting. As discussed, they are missing out, but this is often not their choice. Building quality finance team is costly and SMEs lack access to quality professionals. High employee turnover is another reason which can disrupt this process. The good news is, that there are specialised companies like fdservices that provide quality budgeting, tax and other advice to SMEs, closing this gap.