It’s budget time of the year – for the country and for small business owners and operators as FY 2014 comes to a close and a new financial year looms near.
Preparing a budget for your small business can be tricky for the uninitiated. Most small businesses fail within the first five years often because of a lack of attention to revenue (sales) and expenses (fixed and variable costs) that can lead to cash-flow crises, low margins and low, zero or negative profits.
If you’re planning to prepare a budget for the coming financial year, here are some pointers to help you avoid some of the common budgeting pitfalls.
- Perfectionism While matching expenses to revenue is central to a budget, there needs to be a common sense approach to the level of detail and precision. Trying too hard to include everything inside your budget can lead to frustrations and wasted time. Spend the most time and effort on getting the large ticket item reasonably accurate and use estimates or employ a “last year’s cost + 10%” approach for smaller line items.
- The Hockey Stick A hockey stick budget is one where the forecast revenue/sales are moderate in the first quarter of the financial year; followed by a significant growth in revenue/sales in Quarters 2, 3 and 4. The term “hockey stick” refers to the shape of the revenue growth line on a chart. Looking like a hockey stick, the revenue line is characterised by a sharp rise in the points after a “flat” period. While it is commendable to be optimistic and enthusiastic about the potential demand for your goods and services, it is a rare business indeed that will experience dramatic levels of growth within a single 12 month period. Unless a large volume of sales is already contracted and in the pipeline at the time preparing your budget, it is advisable to build the budget with a more modest ramp up in revenue growth.
- Flat line revenue/sales Nearly every business has both high and low periods of revenue/sales activity over any given 12 month period. This is known as seasonality. It is easy to overspend and create an inflated budget which does not coincide with the seasonality of the income flowing in from sales. You could simply divide annual expenses by 12 and allocate that amount to expenses every month in your budget. However this does not assist in anticipating and managing these lump sum payments as they arise; and can lead to cash-flow crises. For planning purposes, it is advisable to include seasonal adjustments to revenue in the budget and then shift your expense plan to reflect this.
- Not Writing it Down Not recording a list of assumptions can lead to confusion and errors later, particularly if revenue does not perform as expected over the 12 month period or if the expense base in the budget proves to be much too high. Having a note of your assumptions can assist you to make quick and well informed adjustments to your business operations if and when required. Try adding a sheet to your budget spreadsheet entitled “Assumptions”. List here all of the assumptions you have used to build your budget. This may include such items as: % growth in sales month by month, number of new customers, number of repeat orders, unit cost of supplies, % increase in utility bills, frequency of equipment upgrades, number and timing of new staff hires.
- The “Re-Budget” The budget is set in stone. It represents your best prediction at the time, given the knowledge and assumptions at hand. The budget does not change. What can and does change over time is your forecast. As market conditions fluctuate, competitors come and go and marketing activities gain traction, your expected sales and expenses are likely to vary. A well run small business will regularly update the forecast of revenue and expenses (typically once every quarter is frequent enough for a small business) and then every month, they will measure the actual revenue (sales), actual expenses and actual profit/loss achieved and then compared this to i) the original budget and ii) the regularly updated forecast. If you do not regularly update your forecast one of two things will happen – the budget breaks (and gets ignored) or your business will continue to operate on the original budget, resulting in an outcome not predicted at the beginning of the year.
Avoid these common pitfalls when preparing your small business budget and enjoy a Happy and Prosperous New (Financial) Year.
