Budgets are useful for individuals and families. They are critical for businesses. With that in mind, Peter Scully, Marketing Assistant of Rogers Spencer shares his insight into why budgeting is critical for your business, and why budgets matter.
The basics of budgeting
A budget is simply an estimate of income and expenses for a particular time period. The more accurate the estimates are, the more effective the budget will be. With that said, it’s always safest to err on the side of caution with your estimates. In other words, lean towards underestimating income and overestimating expenses.
It’s very common for long-term budgets to be relatively high-level. The further into the future you go, the harder it is to predict income and expenses in any detail. Medium- and short-term budgets, however, should both be relatively detailed.
With that said, the fact that all budgets deal with the future means that they are very much living documents. They can and should be assessed in the light of what actually happens and, if necessary, adjusted. Ideally, any adjustments should be made promptly. This helps to minimise any adverse impact of incorrect estimations or calculations.
It’s absolutely standard for businesses to need to make small tweaks to their budget over the course of the year. If, however, a budget needs a significant adjustment, then it’s advisable to investigate the reason why. It could provide important lessons for future budgets and/or be of interest to potential lenders/investors.
Why budgets matter
The main reason why budgets matter is that businesses can only stay operational if they can pay their bills. This means that their spending has to be in proportion to their income plus any ad-hoc revenue, finance or investment they receive. If there is a discrepancy, then the business either has to reduce its spending or increase its available funds.
Budgets are therefore essentially planning tools. As such, they need to reflect both the practicalities of doing business (e.g. operating expenses, finance charges and taxes) and the company’s goals and values. Having a realistic and credible budget in place also tends to be essential if you’re looking for (further) investment or financing.
You can also use your budget to benchmark yourself against your competitors via their financial statements. See if there are any significant discrepancies between where they are spending their money and where you are spending yours. If so, think about why this is and what it means.
Budgets and cash-flow projections
Budgeting should ideally be undertaken alongside cash-flow projections. In blunt terms, income is always only projected until it’s actually in the bank. What’s more, some payment methods allow the payer to dispute a transaction. This means that the money isn’t actually fully secure until this time is over.
As a result, businesses need to be very clear about exactly when they can expect to receive their income. They also need to think about what steps they can take to maximise their chances of getting paid in full and on time and/or minimising/winning disputes. Finally, they need a plan in place for when projected income does not appear (for whatever reason).
The process of budgeting can therefore highlight important questions around issues such as cash flow management, pricing and pricing strategies, payment methods, credit control and the need for cash reserves and/or available lines of credit. This in turn can highlight important questions about what purchases are made and how they are made.
Budgeting and cash-flow management
In practical terms, probably the single most important function of a budget is to manage a business’ liquidity. This is essentially a business’ ability to pay its immediate obligations out of its immediate resources. Liquidity is so important to businesses that it can be worth paying a premium for it.
For example, the most economical way to buy (non-perishable) supplies is usually to make infrequent, large orders. The larger an order is, the more likely it is that the buyer can negotiate a bulk discount.
Unfortunately, paying for occasional, large orders, even with a discount, can seriously disrupt a company’s cash flow and hence, ultimately, its budget. This is why, in practical terms, it’s often better to make smaller orders. It’s also why businesses, especially SMEs, often use financing even when they have ready cash and why “as-a-service” offerings have become so popular.
On the flip side of this, it is also very definitely worthwhile for businesses to use pricing strategies that boost their cash flow. The obvious example of this is offering (reasonable) discounts to customers who pay in full up-front (on upon delivery). Other options include aiming to move customers onto a subscription model instead of a pay-as-you-go model.
Budgeting and expense management
Another valuable function of budgeting is that it encourages businesses to look actively for ways to reduce their operating expenses. For modern businesses, this often means finding ways to leverage technology more effectively.
Obvious examples of this include the push for digitisation, the adoption of smart technology and the increase in automation. More subtle examples of this include adopting new materials and/or new ways of working to produce greater efficiencies.
The fact that technology is, literally, developing all the time means that new ways to leverage it are being created all the time. As a result, every round of budget-setting becomes an opportunity to find new and better ways to run a business.
It also provides an opportunity to ensure that you are making the most of what you already have. For example, if you have “as-a-service” packages, you can check whether or not they are still the best option for your needs.
Budgets and risk management
Budgets themselves are based on realistic estimates, in other words, what the business expects to happen. The exercise of budgeting is therefore an opportunity to look at potential risks and opportunities and consider how likely they are to happen. In the case of risks, businesses should also look at the worst-case scenario and consider how to mitigate it.
In many cases, the answer to this question will involve cash reserves and/or insurance. In some cases, it will involve having some form of backup plan (e.g. a disaster-recovery site). Whatever form of mitigation is chosen, it will need to be costed and the costs incorporated into the company’s budget.
