You don't start a journey without a destination in mind - the same should go for your business.
Running your own business is never easy. With a million things to attend to, it can be easy to overlook the small things - like creating a budget. In fact, a recent survey found that half of small businesses did not create an official documented budget in 2020. Yet it's a practice that many experts consider critical for any business to succeed.
A budget is a financial plan used to estimate a business's anticipated revenue and expenses for an upcoming period. It's a vital business planning tool - a road map for the company to ensure it is on the right path to meeting its goals. By providing a detailed view of your assets, revenue, and expenses, businesses can make better decisions about staff, investments, and expansion.
Having a budget also shows you have a concrete plan for the company. When it comes to taking a loan or discussions with potential investors, this comes in especially handy. Internally, this helps employees understand the priorities of the business too, setting a clear, coherent direction for the company to move as a single unit.
A budget is crucial to understanding how well your business is doing, or otherwise. Here are four things to consider when creating your budget:
1. Account for your sources of revenue
The first step to creating a budget is taking stock of all your sources of income. This can be based on last year's sales numbers or industry averages.
To make these estimates more accurate, yearly variations should also be considered. These include things like future industry growth, difficulties in collecting debt, and future liquidity or funding gaps.
A good budget will also plan for at least three scenarios: worst-case (for instance, where one might see a 10 to 20 per cent decline), expected case, and best-case scenarios (for example, a 30 per cent growth).
2. Determine your fixed costs
Fixed costs refer to expenses that don't change regardless of how much you make. This includes things like rent, insurance, and utilities.
Even if you don't make any sales, you will need to have enough cash to front these fixed costs. As such, a clear understanding of these payments is very essential. As a rule-of-thumb, companies should set aside enough cash to cover three to six months of fixed costs.
A good budget will also determine how low a company can price their products to sustain their fixed costs.
3. Adjust for variable costs
Another expense to account for are variable costs. These are expenses that vary based on month-to-month performance and activity. Amongst others, they include things like material costs, commissions, and transaction fees.
Amid the COVID-19 pandemic, one major consideration will be the availability of resources. Movement restrictions and port closures have the potential to create manpower and resource shortages. Companies need to anticipate these challenges to mitigate losses.
If a significant portion of your variable costs are made up of raw materials that are commodities - like steel, palm oil or sand - you should also consider using hedging tools. These help businesses mitigate risks by adjusting selling prices or engaging in fixed price contracts.
4. Check for one-off spending needs
Just like how you need to replace your handphone or laptop every four years, businesses need to make similar purchases from time to time. This includes things like updating old equipment, investing in technological capabilities, or automating manual processes. Whether it is office furniture or new software, it is important to plan for these expenses.
Be sure to also leave some funds aside for any unexpected expenses, such as a data security breach. You never know when you'll have to deal with an emergency.
With a proper budget, you can then start doing more with forecasting - making projections for your business. These can come in handy when making necessary adjustments to your areas of focus or spending, given the variables that can take place over the course of a year. This is especially pertinent in this uncertain economic climate, where clients can be increasingly price-sensitive, or landlords less tenant-friendly.
Together, a budget and forecasts can work together to give you a fuller and more detailed picture of your business performance, while pointing out areas for improvement.
For small businesses, it may be tempting to discount mundane accounting tasks. But focusing your attention on the details always pays off in the long run.