Updated: Jan 24
Do you have a budget?
I am increasingly astounded by the number of businesses that I come across that do not have a budget. Without a proper budget in place, a business cannot understand where they currently are, and are unable to make key business decisions that can drive their business forward. So, what is a budget anyways and why is it important to you?
A budget acts as a financial road map for your business. Imagine taking a 2-day road trip with your friends. Happy days right? What happens if half way through the journey, you realize that you do not have enough resources (i.e. fuel, money) to complete the journey? You'd be stuck in the middle of nowhere! That is exactly how a budget works. Without a proper understanding of where we are in our 'journey' and constantly assessing ourselves, we may find ourselves 'breaking down' in the middle of nowhere. Which brings us to the next point, so....
How do I create a budget?
A business budget consists of primarily three things;
2) Variable and Fixed Costs
3) Staff Costs
By understanding how to use a 'baseline' figure for each category, you will be able to make an informed decision the next time you have to make a capital commitment for your business.
Generate a profit and loss report by month to see how you are tracking in comparison to the past few months. In this process, you will start to notice trends in your business.
A good practice within this report is to actually create separate income categories for the different aspects of your business. A key trick while doing this is to ask yourself, "how are my different service lines performing?". If you are a tradesperson for example, you are able to split your sales into a category for your services, and a category for the goods you sell. This will allow you to better develop a 'baseline' for each category and lead to better and more accurate budgeting.
"A common approach I see with budgeting is just to use an 'average'. While this is not incorrect, it may not be entirely useful for budgeting purposes. A better approach is to actually look at the different service lines of your business, have an understanding of what is the 'minimum' you are able to achieve in each service line in which month, and forecast that way. As a rule of thumb, it is always better to over-budget, than to under-budget. The more specific you are, the better your budget will be.", says Justin Wong, the Financial Comrade at PAQ Group - Bookkeeping Specialists.
2. Variable and Fixed Costs
What are some of the costs that you incur, that do not move with your top-line? Some of the examples are items such as rent, electricity, subscriptions, etc. By plotting and listing these items out, we are able to have a 'baseline' understanding of how much we are incurring in costs every month. On top of this, we are also able to develop our break even point with this. In other words, how much do we have to make/sell, in order to cover our fixed costs?
Take a look at your business. What are the fixed costs that do not change?
3. Staff Costs
Building an excellent team around your business is fundamental to success. When budgeting for employees, it is useful to ask the following questions:
a) what portion of my employees are driving sales/producing revenue?
b) what is my staff utilization rate given X revenue?
By understanding the portion of your employees that produce revenue, you can start understanding your current 'capacity' - in other words, "what is the maximum revenue that I can achieve given current manpower directly related to production of revenue?" This then, will allow you to understand what your current staff utilization rate is, in comparison with your maximum utilization rate (i.e. thereby creating a more realistic revenue to sales ratio).
This metric, is particularly relevant to high staff to sales ratio industries that is highly reliant on employees to produce revenue. Understanding your current utilization rate is not only useful for internal purposes, it also allows you to use this information, and compare externally to see how your peers are doing in comparison, what is causing the gap in performance, and actionable steps that need to be taken to minimize this gap (if any).
For staff that are not directly related to production of revenue, they will basically form part of fixed costs (i.e. costs that do not change much with per incremental increase in revenue).
Putting it all together
After compiling all these data, you will have some really powerful information that you are now able to collate together to build a purposeful and realistic budget.
While this will take some time putting together, I assure you, this budget will not only serve you in understanding where you currently are in your business journey, it will also act as a catalyst in allowing you to make key business decisions and grow your business.
What was your #1 takeaway from this post? Do you feel inspired to start your budget building process?
Let us know your thoughts!
About the Author
Justin Wong is the Financial Comrade at PAQ Group. The mission of PAQ Group is to create a stress-free bookkeeping experience and to empower entrepreneurs with financial know-how so they are able to create a more successful business.
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