For many business owners the first time they attempt to create a budget is when the bank says they need to see one. Typically this is prepared by their accountant, reviewed by the bank, and then promptly forgotten about forever. This is not ideal, let me explain why.
First up, what exactly do we mean by ‘budget’? A budget is a simple prediction of the upcoming income and expenses for your business over a specified period, usually 12 months. Normally these are broken down month-by-month and will look just like a profit & loss statement, the main difference being that the figures are estimates of what is to come, rather than a recording of what has already happened.
And why is having a budget important for a business? Oh, let me count the ways!
Decision making. If you aren’t able to reliably estimate where your business will be in 3 months, 6 months, a year – how do you know if you can afford to take on that new staff member, or move to that new premises, or invest in new technology?
Resourcing. Solid budgeting means that you will see, in advance, any resourcing issues and can solve them well ahead of time. What do I mean by resourcing issues? Mostly we’re talking about cash flow (i.e. making sure you won’t run out) and staffing (i.e. making sure you’ve got enough people hours to get upcoming work done).
Investment. If you’re thinking about seeking investment you’ll definitely need a budget to demonstrate to potential investors what the future holds for your business. Even if you’re not thinking about investment now, if you’re in the habit of keeping a budget it means it’ll be easier to create one when the time comes and it’s far more likely to be accurate because you’ll have had practice.
Paying staff. Not sure if you can afford to pay your key person a bonus or salary increase? A budget will help answer those questions.
Tax time. Being able to predict what your tax bill will be and working with your accountant to include tax payments and instalment amounts in your budget will increase it’s accuracy and stop you from having any unpleasant tax-man-related surprises.
As you can see, there are reasons aplenty for keeping a budget. For me, the key one isn’t mentioned above and it’s peace of mind. This peace of mind comes from knowing what is coming up – I like having a rough idea of what the year ahead looks like and having targets to meet. If we fail to meet target one month we can reassess and change strategy if needs be. Waiting until the end of the year and thinking “oh, that was a crap year” isn’t very helpful – wouldn’t it be better to resolve it after 1 month rather than wait out the year?
What’s the difference between a budget and a cash flow forecast?
Good question! They have the same foundation (i.e. predicted profit and loss figures), however a cash flow forecast adds an additional layer of information (and complication) to the picture. It will include the following cash items that aren’t typically featured in a normal budget:
- Capital expenditure
- Loans in/out including repayments
- BAS payments
- Other ATO payments
- And most importantly, predicted cash balances.
The key difference is really that last one. A budget is a prediction of your profit & loss statement over a certain period, whilst a cash flow forecast will have that as well as your predicted cash balance over the same period. A good cash flow forecast will allow for what is known as ‘three way forecasting’ which means it has profit & loss items, cash balances as well as balance sheet items in the forecast. This obviously complicates things, but it does help to give a more holistic overview of where the business will (or should) be in the future.
Where to get started?
If you don’t already have a budget I’d strongly recommend spending some time putting one together. If you’re using Xero, which I hope you all are, you can use the Budget Manager tool found in Xero under Reports. It will allow you to download a template for a specified period (say, the next 12 months) and then you can complete the template before uploading back into Xero. You can then run a report (Budget Variance report) that clearly shows how your actual performance is tracking against your predicted performance. This is a fantastic tool to keep you on track – if you see you’re falling off budget, interrogate the reasons why and make changes to resolve it so you don’t fall further behind as time goes on. And how do you know what figures to put into the budget? There are a few key things to think about when forecasting the upcoming year, including:
Review of the prior 12 months, taking note of seasonal fluctuations
- Current staff/business capacity
- Growth plans
- Planned investment expenditure
Creating a budget is part art and part science and it will take a little practice before you’re producing budgets for your business that are reliable and accurate. Don’t let that put you off though, it’s part of good business practice to have an up-to-date budget that is regularly reviewed and reported against. Get stuck in today!
Ben Fletcher is the Managing Director of Generate – the leading accounting & advisory firm for creative and innovative business owners.