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Does My Business Need a Budget?

Often when businesses start up, a business plan is prepared and presented to a financial institution to secure financing.  Upon successfully obtaining a loan, the budget or forecast presented in the business plan is a distant memory for new business owners who quickly get involved in running their business operations.

However, if you are serious about your business, you should be serious about managing this budget for your business. Not only is it important to have a budget, but also to monitor and to analyze it on a regular basis. Ensuring that performance targets are being achieved can only be verified this way.  A budget is like a roadmap for your business – it tells you where you where your destination is. The route taken is the journey of regular reviewing of financial reports and variances to heading down the desirable path.

In my experience, 50 percent of small or mid-sized companies prepare budgets.  Of those companies, less than 25 percent regularly review or analyze their budgets during the year. The main reasons for this typically is the following:

  • Management does not have the time to review the reports
  • Accounting staff are behind in bookkeeping, and the reports are not delivered to management on a timely basis
  • Accounting records contain errors and the reports require significant adjustments to make the reports useful

It is very useful to know at various points during the year whether your business is on track or not.  There are a few steps to successfully accomplish this.

To start, examine the current budget against the actual results on a quarterly basis minimally. Look at each month, as well as year-to-date totals. Review each line item and look at the differences, then examine what caused those differences. Were your projections off, or was performance better or worse than expected? Was this due to regular occurrences or one-time incidents, such as weather, a manufacturing delays or an accident?

If sales revenue fell below budgeted levels do the same analysis by breaking down sales by product, territory, store, or factory–based on the metrics you use to create your projections.

Finally, analyze the cost of sales and the resulting gross margins on your products or services. Again, you should examine the budgets and results by the breakdowns that make sense for your business and point to actionable items. Do the same steps for all overhead expenses.

This gives you the opportunity to make appropriate changes in operations which allows the company to get back on the right route. Once you determine what happened and why, take another look at your original budget and determine which, if any, year-end targets are still attainable. Now you’re ready to build a new budget, along with an action plan to achieve it.

Its recommended this process is done with your entire management team—not just the finance department. Those on the front lines will have precise information about why shortfalls occurred, and will most likely contribute meaningful suggestions and corrective actions.

It is critical to re-emphasise the importance of regular review and variance analysis. Waiting until the end of the year to find out from your external accountant that the company did not achieve what it set out to do can lead to a disappointing outcome.

For those businesses who are successful in securing financing with a financial institution, it is important to note that a required annual, or sometimes more frequent budget review, will be required.  The purpose of this from the bank’s perspective is to ensure that any covenants in place are met and the overall financial heath of the business is still in tact.

However, waiting until after year end to make changes, may lead your business to the penalty box with your bank if your offside on your covenants. Although the bank will usually work closely with you to get you back on track and to stay out of their special credit department, this is an exercise that can typically be avoided if the proper steps are taken.

At Pacific Chartered Advisors LLP, we work with our clients to understand their business and to create a budget that is realistic, simple to follow and easy to monitor. Whether you have debt on your balance sheet or want to stay out of debt, all businesses can benefit from having a budget.