[vc_row][vc_column width=”1/4″][/vc_column][vc_column width=”1/2″][vc_column_text]Budgeting is an important part of good management. Company leaders shape and adjust their corporate and business unit strategy, then they put together a combined budget for anticipated revenue and costs as part of an operations plan to achieve the objectives set in the strategy.
Since the financial crisis in 2008, the use of budgeting as an effective management tool seems to have diminished somewhat. With so much economic uncertainty and disruption, it is tempting to dismiss the budgeting process as an academic exercise that, despite your best efforts, will not represent reality. The mistake here is to think that this economic volatility makes the budgeting process an exercise in futility. It turns out that the more uncertainty a company faces, the greater the need to budget.
It is true that budgeting done poorly can become a burdensome process that consumes a good deal of company resources only to create an updated and refreshed version of the previous year’s document. But budgeting done well can be an effective tool that helps crystalize your strategy and sharpen your plans for operations and marketing.
No matter how you do it, planning experts say budgeting is critical for ongoing company success. To get some advice on how small and mid-sized businesses can effectively budget, we spoke to two seasoned Ann Arbor area tax and planning professionals.
Chris Sing, CPA, CGMA, MBA, is Partner at Rehmann, a CPA, business consulting and financial services firm with nearly 800 associates in 21 offices in the Midwest. Sing heads up the Accounting, Tax and Consulting (ACT) practice, which includes a breadth of business advisory and consulting services, including payroll processing, setting up QuickBooks, completing tax returns, helping client engage potential investors, and assisting with the sale of a business. Sing works closely with business clients and owners to help them take their businesses to the next level of performance and profitability.
David Armstrong, CPA, CFP®, is Partner at Ann Arbor-based Edwards, Ellis, Armstrong & Company, a group of CPAs who provide accounting, tax and management advisory services. Armstrong has been with the firm for over 20 years and operates a practice that focuses on small businesses in a variety of industries. Armstrong’s expertise is in tax and he helps small businesses, corporations, and other entities with tax planning. A typical client for Armstrong is a small business with revenues under $10M a year.
Here are five things we gleaned from our conversations with these planning professionals.
1. SUCCESSFUL COMPANIES BUDGET
Entrepreneurs start their business to do a lot more exciting things than accounting or budgeting, so I understand that they may not be naturally focused on budgeting. Exercising discipline in the area of budgeting is often a tough sell to an entrepreneur.
I have to say, though, time and time again I have seen that first and second stage startups can’t quite pinpoint where or how things went well when they are successful. Then, when things fall off, they can’t quite figure out what went wrong. As much as I understand that they like to budget, a budgeting practice of any sort is critical for long-term sustainability. You have to understand why things are or are not going well.
If you’re starting from no budgeting at all, the tool options can be overwhelming. The clients I see that are successful, especially in their earlier years, make some sort of simple plan. Many of them use QuickBooks as an account tool, since it has an easy budgeting module. The key is to just get something simple together that can serve as a guide to where your head was when you made the plan before the year started. You can learn so much using this simple plan as a guide.
The first point of advice I have to small business clients is to budget because it’s a critical piece of planning. As basic as that sounds, how can you make future decisions accurately if you don’t have at least a realistic forward-looking viewpoint?
Many small businesses, for whatever reason, do not typically invoke budgeting as part of their planning. Many of the business owners have been around for a long time and they are comfortable just looking at the business in a general sense. Part of my advice to them as we reach the end of the year is that this is really an important tool to be employing.
2. AN ANNUAL BUDGET WORKS BEST
The timeframe of the budget really depends on the business. What I often see is that predictability of the business’s revenue cycle often dictates how far out the business owner is comfortable budgeting. Typically, though, an annual budget is the guideline. Active management teams balance this with 3-5 year strategic plans and monthly rolling forecasts.
An annual budget generally stays static throughout the upcoming year, unless significant circumstances affect the business. It also becomes an excellent benchmark to represent how the decision makers expected the year to play out. In my opinion, the most effective management process with respect to budgeting is a monthly and year-to-date comparison, with thoughtful explanation and contemplation of significant variances and an ongoing fluid forecasting process that actively analyzes and reacts to actual financial results.
I typically recommend doing a yearly budget, with monthly budget components to it. I’m not much of a fan of quarterly budgets. It’s not that one is wrong and the other is correct; it’s just my personal viewpoint.
There are exceptions, such as businesses that have seasonal revenue that may have a reason to focus in on a specific quarter. Also, if there is a significant change to the business, such as losing a key contract, there may need to be a revised budget because something was significant enough to have thrown off projections.
The point is that if you have an annual budget and you’re comparing budget to actual, looking at variances, and analyzing items, you can build in flexibility to the budget. If you spend time redoing or modifying a budget each quarter, it can be too much time in the details. I think more time should be spent planning the annual budget and then taking a little time each month evaluating where you are against budget and determining why you were off budget.
3. BUDGETING HELPS MANAGE PROFITABILITY
What I usually find is that it’s not hard to budget expenses, but it’s really hard to budget revenue. This is especially true for entrepreneurial companies where revenue could be coming around the corner and the pipeline they have today may not be what they have for next quarter.
If you’re finding it hard to drill down to the details of where the revenue will come from, you may want to forecast revenue by predictability. Say, for example, you have ten prospective customers each with a potential sale of roughly $500,000 in Q1. To forecast revenue, you might want to apply a chance (e.g. 20%) of closing the sale in Q1, giving you a Q1 forecasted revenue of $1M ($500K * 10 * .2).
If predicting revenue for a whole year out is just too intimidating, then just go to Excel and at least set up something monthly based on your monthly expenses. In this case you’re almost operating by trying to figure out what sales you need to close in order to break even as you’re growing the business. This is more of a cash flow tracking process. In some cases, such as a startup, this is even more helpful because you’re just trying to make payroll.
The budget should have two views: a cash flow view and a P&L view. The two may be similar if the business doesn’t really have receivables, such as a restaurant.
For most businesses, though, you’re going to have delays between purchasing and selling inventory, or delays between billing for a service and when you receive payment, so it’s good to have the budget in both formats. Obviously, cash is one of the important metrics for every business, hence the importance of having a budget to make sure you’re managing it well.
4. PLANNING FOR HEALTH INSURANCE IS CRITICAL
Health insurance is the wildcard for 2014. Most businesses I work with are budgeting for some increased costs while still scrambling to get their arms around how much of an increase they will see and how much, if any, they will pass along to their employees.
If you’re a small business and do not offer health insurance, this issue may not affect you much. However, you should still be knowledgeable about your options. The main point is that when you’re going through the budget process, you’re forced to look at these key costs that may change year to year.
We recommend that our clients periodically perform some form of health insurance analysis. Some of our clients, for example, have gone to a semi-self-insured model where the company pays the deductibles for employees. If the employees are generally healthy then the company gets a lower overall cost for health insurance while still providing its employees with full coverage.
5. CONSULT BOTH INSIDE AND OUTSIDE THE ORGANIATION
Surround yourself with advisors, other business leaders, and people you respect. A planning team of one is probably not as helpful. Sometimes advice from seasoned professionals can help validate and shape a realistic business plan. An outside resource can help kick the tires, ask provoking questions, identify potential problem areas, and help you form a realistic plan.
When you get toward year-end it’s a good time to consult with your advisors, including your CPA. It’s a great time to be evaluating the business and looking forward toward next year, particularly if you’re anticipating more profit, which may impact tax decisions or plans to set up certain types or retirement plans.
Don’t miss the opportunity to think forward and make a future plan for your business. The discipline of budgeting can be executed formally or informally. The critical common element is a thoughtful measurement tool that helps you manage your business’s progress.
My advice to businesses this fall is to carve out the time to plan your 2014 budget and to put a forecasting process in place to actively manage your business’s financial plan throughout the year. You need to take time to just step away and think about your business without the day-to-day crisis around you. This usually means removing yourself from where you do business, which I think is what most business leaders need to do to strategically think about your business.
You want to be realistic in your budgeting, and you don’t want to have too much detail where you get lost in the details. Remember, the budget is supposed to be a planning tool. Keep it simple, be realistic, and build some flexibility to adapt to the changing circumstances.[/vc_column_text][/vc_column][vc_column width=”1/4″][/vc_column][/vc_row]