As I work with clients and meet entrepreneurs, I have the opportunity to observe a variety of management styles. One thing that stands out is how few people create an annual budget. Those that do tend to take a “quick and dirty” approach. They add an assumed, across the board growth percentage to the prior year’s numbers or they take a guess at what the numbers might be. Needless to say, the “quick and dirty” approach does not yield useful numbers.
A budget is an important, necessary tool. You don’t embark on a cross country driving trip without a map. Why would you not do the same for your business? You have far more to lose if your business fails than if you don’t make it to your vacation destination. A budget converts your business strategy into numbers. The numbers serve the dual purpose of projecting profitability and creating financial benchmarks against which actual results are compared.
Not only do you want to know how much you are above or below budget buy why. The “why” is information you can use to take action. It pays to be as detailed as possible in designing assumptions. Without the detail, you can’t easily draw conclusions.
A carefully crafted budget will tell you in advance whether your strategy has financial merit. Start-up businesses expect to run deficits, but established ones do not. When you know in advance there will be a net loss or a cash flow deficit, you can take action today to correct your course and follow a more profitable path. The budget will help you stay on track by telling you how much you can spend in certain areas, when you can hire new employees and when you can purchase new equipment.
A good budget is necessarily complex and time consuming because it must capture your vision, reflect your business strategy, account for outside forces and be realistic. It takes great care and skill to embody those qualities in a numerical representation of your business.
Remember that even the best budget is not accurate. No one can predict the future. The best you can do is use conservative, realistic assumptions to produce a projection that has a high probability of occurring.
A common myth is that budgets are static. A good budget changes when significant assumptions change. If you land a major contract that was not anticipated, for example, it would make sense to adjust the budget for the expected, significant effects on the business. A major influx of revenue is usually tied to a rise in costs. You may have to hire additional employees to handle the volume or incur additional costs to meet the demand. A flexible approach keeps your budget relevant and allows you to use it as a roadmap.
Don’t attempt to create a budget all on your own. Even if you have the expertise to create a good budget there are two reasons not to do it yourself. First, an outside, objective viewpoint will keep your budget “real”. A professional may even spot things you missed or have ideas you haven’t thought of. Second, budgeting is not the best use of your time. Growing and managing your business is. This doesn’t mean that you are not involved in the process. To the contrary, you are needed to create assumptions, determine goals and evaluate the model’s realism. The actual act of creating the budget should be left to an expert.
Now that you understand the importance of budgeting, stay tuned for December’s installment of Mindful Musings were we budgeting techniques and tips for getting started.
