The basis of every budget is an estimate of the income of the business. The more accurate the revenue estimate, the more sturdy and useful the budget is for the business owner. The problem, says Roelofse, is that the income estimate is also the part of the budget that business owners most often get wrong.
Probably because most entrepreneurs are optimistic by nature, they tend to overestimate sales. A budget with overstated income can be just as bad as having no budget at all, because it knocks over every other part of the budget. It gives the business owner a false sense of security that budgeted expenses will be covered.
There are a few ways in which entrepreneurs can temper their flights of fancy and force themselves to produce realistic revenue estimates. The most obvious is to base future sales on historical sales data. Any deviation from past sales must be based on realistic factors. When the economy falls into a slump, for example, it would be dangerous to think that your sales will increase in the coming year.
Then, it helps to have two budgets, one for what Roelofse calls the “high road” and one for the “low road”. In other words, a budget for when things go well, and another for when the weather turns bad.
Roelofse recommends that the low-road budget be a break-even scenario which will reflect the minimum sales required to meet overheads and keep the business going.
Keep it simple
You don’t need a fancy app or expert set of skills to draw up a budget. Budgeting is a basic exercise that every business owner can do on a simple spreadsheet with three columns – budget, actual and variance.
If you know your way around your accounting software and it allows you to draw up a budget, use it. But a simple spreadsheet is more than enough for the exercise.
Do it yourself
Accountants are useful for helping business owners with tax and financial statements, but business owners who leave budgeting for their accountants are probably over-reliant on them, says Roelofse.
“Nobody has a better feel than the business owner of what levels of sales can be expected in the coming months, and what kind of expenses will have to be made to meet those sales and still pay the rent. If business owners cannot draw up their own budgets, they can ask their accountants to assist, but they must understand what the accountant does,” says Roelofse.
Do it regularly
While large corporations go through an annual budgeting process, it is probably better for medium and small businesses to rethink their budget more regularly, because resources are fewer to bridge over sudden environmental and internal upheavals. A budget drawn up for the next quarter is invariably more accurate than one drawn up for the next twelve months.
Whatever the frequency of the budget-planning process, it is vitally important that any business compares its actual sales and expenses against the budgeted amounts at least once a month. If not, sales dips and rising expenses will only be noticed once it is too late.
Roelofse advises manufacturing and retail businesses to integrate regular stock takes with their budget checks. The smaller the gross profit margins of the business, the more regularly stock takes should be done, because there is less room for error.
Budget for your extra cash
Budgeting is not only to prevent business death by cash-flow crunch. It is also vital to help entrepreneurs plan for what to do with their extra cash when the going is good. Roelofse says he has often seen business owners who had been sitting on a pile of cash wondering where it has all gone within a few months.
Sensible budgets include plans to invest extra cash into accessible short-term money market accounts, for example, or into long-term investments such as buying the building from which the business operates if the entrepreneur is sure that income and profitability can be sustained.
Be ready with Plan B
Over and above the low-road, break-even budget mentioned before, sensible business owners have a plan for when their budget, even their break-even budget, suffers a major knock – if a major client goes bust, a fire or break-in disrupts production, a key staff member quits, or an aggressive competitor suddenly emerges. Entrepreneurs have the temperament to live with such risks. The best of them plan for such possibilities, and always keep their budgets close at hand.