Budgeting? Forecasting? Variance analysis? Isn’t that for large conglomerates with hundreds of people in the Finance department who can burn the midnight oil to generate these reports? As a small business owner, this is most likely your line of thought now. We agree.
Most small businesses would have a fair understanding of their monthly revenues at any point in time, and also a good estimate of expenses. But a huge Budgeting exercise every year to ensure that you have enough funds to cover your expenses is a little too much to ask of a small business.
BIG BENEFITS of Budgeting
But what if we said that Budgeting is more crucial for SMBs than for large enterprises? For small and medium businesses, regular budgeting can mean the difference between merely surviving or growing profitably. Though painful, a well-planned budget can help you understand seasons of scarcity, and seasons of plenty, helping you decide when to invest in growth.
Better Cash Flow Management
Budgeting requires you to look into your income and expenses each month, giving you a better idea of your cash flow pattern. By plotting a chart of when revenue is expected and when expenses occur, SMBs can ensure that they have enough liquidity to cover their operational needs.
Realistic Goal Setting
No more guesstimates in your goal setting. If you have visibility into your yearly income and expenses, you can set more realistic SMART(specific, measurable, achievable, relevant, and time-bound) goals to guide your business. It will also be easier to communicate these goals to your teams since there is visibility into how much budget they can utilize every month to achieve their targets.
Informed Decision Making
Many times, crucial decisions are delayed due to a lack of information for the top management and stakeholders. With proper budgeting, there is visibility into income and expenses each month, enabling better and more informed decisions, made quickly. Whether it’s about building new teams, investing in new technology, or expanding to new markets, budgets can help you decide when to do them effectively.
Greater Investor Confidence
Along with your employees, your investors and stakeholders will have better confidence in your credibility if you have a well-planned budget that takes into account the risks and contingencies you would have to face.
Effectively presenting your budget to the investors will help build your confidence and credibility, projecting the image that your business is being managed prudently and that there is a clear plan for financial stability and growth.
Proper financial planning and budgeting will make your business better prepared to face economic fluctuations or unexpected crisis situations. A well-planned budget is not set in stone, it allows you sufficient margins for contingencies and unexpected downturns.
When should you start the Budgeting exercise?
If your business needs the budget to be ready and presented to the employees by the beginning of the financial year, the planning should start in Q4 of every year.
- January is a good time to start gathering data from different departments on their expenses, planned capital expenditure requirements, extra resources needed, and so on.
- By February, the data should be collated and checked for discrepancies or errors.
- By March, the budget should be ready so that it can be presented to your employees and stakeholders before the beginning of the next financial year in April.
This way, your employees start the year with confidence knowing what is expected of them, and how to achieve those expectations. It also instills confidence in your investors and stakeholders to be informed about your budgets and plans at the beginning of the year.
How to do the Budgeting exercise?
There are 2 common approaches to budgeting:
- Base plus – In this method, you use the budget of the previous year and add a margin of say 15 or 20% to it to account for inflation and finalize the current year’s budget. There are several drawbacks to this method as it fails to account for any major change to your business in the current year, expansion plans, or contingencies.
- Zero base – In the Zero base method, the teams are asked to forecast expenses based on major line items in their department. Since the past numbers are not taken into consideration, this can result in wild estimates that are way off the mark.
So, what is the ideal method?
If both methods mentioned above have their limitations, there should be a middle ground for you to start from. Let us create a Step-by-step approach to ensure that you have a well-thought-out budget.
Step 1 – Variance Analysis for each team
This step should be carried out within the team, with data provided by the Accounts team. The previous year’s budget should be looked into with the variances between the budgeted and actual amounts.
The team should investigate why these variances occurred and how they can be taken care of, in the next budget.
Step 2 – Goals and Plans for the coming year
The team should then discuss internally their plans for the coming year, whether there would be any additional manpower needed, capital expenses they might incur, and contingencies they need to account for. Based on the strategies, the team should set goals to be achieved in the coming year. This will empower the team with the freedom to make the best decisions when they do goal-setting and planning for themselves.
Step 3 – Budgeting for the coming year
The team should then internally create the budget for the coming year, based on the previous year’s budget, and their plans for the next year. The budgeting numbers would obviously account for any major expenditures the team might incur since they have also completed planning for the coming year.
Each of these steps would be 2–3-hour sessions or even longer, depending on the size of the team and the size of their operations. In one week, the team will be ready with their budgets.
It would be good practice for management to provide a rough ceiling or a percentage increase that the teams need to restrict themselves to.
Step 4 – Collating budgets from different teams
Team leaders should come together with budgets from their respective teams, compile them together, and present them to management. Team leaders should be in charge of presenting their team’s budget to the management, with reasons for each increase or decrease, and also be prepared to answer questions relevant to their budget.
Some owners might not prefer the teams to discuss their internal budgets with other teams in the organization. In that case, the finance department would collate the information and present it to the stakeholders.
Step 5 – Approval from management
Once the stakeholders approve or make modifications, the budget can be circulated back to the team members. If there are major changes to the budgeted amount, the onus is on the management to convey the reasons for these changes to the team members.
Step 6 – Finalizing and publishing the budget
Once the management as well as individual teams approve the budget, it is finalized, published, and stored where it can be easily accessed and monitored. Make sure to plug in actual numbers every month so that the team knows how they are doing concerning the proposed budget.
Step 7 – Monitoring and tweaking
You as well as your team members have spent a lot of time creating, tweaking, and perfecting the budget. The worst crime you can do is to ignore it for the next 10 months while you go on with your work. Everybody in your organization should have visibility into current vs. budgeted performance.
Variance analysis can be done once in the middle of the year around August to take stock of the situation. Remember that your budget can be tweaked at any time to reflect actual market conditions, or the ebb and flow of your business.
Challenges in Budgeting for Small and Medium Businesses
The 7-step budgeting process described above might be the ideal situation, but for many companies, there are several challenges to implementing this process.
Lack of accurate financial data
It is a waste of time and effort to start budgeting from scratch each year. All organizations look at their previous year’s revenue and expenses before starting the Budgeting exercise. If timely and accurate data is not made available to team members, it is not prudent to expect them to come up with strategies and goals.
If your financial reports are generated only after the financial year ends in March, it gives you no time to budget, plan, and disseminate that information among your stakeholders. Make sure you have people or software in place to ensure that accurate financial data is available to all the teams regularly so that they can monitor their performance and expenses vs. budgeted expenses.
Limited Resources and Expertise
If you do not have the right team to generate financial reports or previous years’ data, the entire budgeting exercise becomes very difficult. Or if you have single-member teams – just one person each for marketing, HR, sales, and, IT, budgeting can be just one person’s opinion vs a team brainstorming to come up with it.
When you have limited resources, the management or head of the company will have to take an active role in setting the budgets for each time, spending time exclusively with your employees to help them plan ahead. This is an area Finavi CFO can help you with. We have many years of experience helping small and medium businesses draft budgets and strategic growth plans, that align with their budgets and goals.
Market and Economic conditions
However extensive and thorough your budgeting exercise, it can all turn topsy-turvy with market or economic conditions. I am sure most companies were caught unawares during Covid you’re your entire workforce had to be shifted to remote working, and industries like tourism and hospitality came to a standstill.
The only way to overcome these conditions is by being nimble on your feet. Do not be rigid in your plans, goals, or budgets knowing that uncertainties will arise. Keep aside some emergency funds that can be liquidated quickly. Also, research low-interest loan options that can come in handy in case of contingencies.
Lack of Proper Tools
Most businesses rely on spreadsheets to generate budgets, and this can be cumbersome as well as error-prone. If your teams do not have experience in using Excel spreadsheets, they will struggle to present all the relevant numbers comprehensively.
There are several budgeting tools that can help you breeze through budgeting. But they all need some initial investment for set up, and a few days of training for your teams before you can get going. Here are some of the tools you can look into:
Each tool has its strengths and weaknesses, and the one you choose should be the one that meets your requirements as closely as possible. Short 2-3 tools that will work for your business and request demos. Instead of getting the sales team to rattle on and on about its features, you have to make a list of features that matter the most to you. Ask specifically to show you those features, before finalizing a budgeting tool.
You cannot stress the importance of a proper, efficient budgeting practice for emerging businesses. While challenges cannot be wished away, proactive planning can help businesses overcome these obstacles and create robust, adaptable budgets. If you need help with budgeting for your business, reach out to Finavi CFO today. Our diverse range of Financial services like Accounting and Compliance, Financial Planning and Analysis, Financial Reporting, Investment Advisory, Employee Benefits, and Valuation Services can help you grow your business profitably, with the right financial strategies.