Tuesday, October 27, 2009

Budgeting Part III: How to use your budget to manage your business

The question that I often receive from small businesses regarding creating a budget is “What’s the point?” Underlying that question is the real question, “How do I use a budget to help me manage my business?” So let’s attempt to address that question.

First of all, when we talk about creating a budget, we usually mean a Pro Forma Profit and Loss Statement. In essence, if everything goes as planned, this is what our profit (we will only think positively here) will look like. I recommend taking this one step further and also creating a Pro Forma Cash Budget, budgeting for when you actually expect to receive and spend your cash. This will allow you to anticipate when you are going to have an abundance of cash and when you are going to have some cash needs so that you can plan for them. For example, if you run a retail business you can expect to do most of your business in November and December so you will end the year with a large cash balance. Before you spend it all or hand out large bonuses, look at your Cash Budget for January through April to see how much you money you need to keep in cash to get through those tough sales months.

Once you have your budgets prepared and you have finished your first month in the new year, do a comparison between your actual amounts and your budgeted amounts. Most importantly, be sure that you can explain the variances. If your Cost of Goods Sold is higher than expected you might want to be sure that it is because your Sales are higher than expected as well. If your labor expense was higher than anticipated can it be explained by an unanticipated order or have you not been watching your overtime closely enough? If you are a restaurant and your food purchases have increased but your sales have not, you may need to make sure that someone is not stealing food from you.

For each of the explained variances you will also want to consider whether it is a one-time anomaly or if this is something that you expect to continue. If it is a one-time event and you have overspent your budget then you know that you will need to adjust your spending down in a different month. If it is an event that you expect to continue, then you will want to adjust your budget to take the change into account. The favorable adjustments are easy. It is the negative variances that require some decisions on the owner’s part. Just remember that you developed your budget based upon your company’s strategy, which means that you need to make sure that all adjustments to your budget are also in line with your strategy.

The point of a budget and a good financial management policy is that you have planned for what you expect to happen and you are now analyzing the data and reacting quickly to your business needs.

A strong grasp of your business finances is essential to running a successful business. As with all things financial, if you find that this is not one of your strengths, then don’t just push it aside and ignore it. Get the help that you need.

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