“Rule No. 1: Never lose money. Rule No. 2: Never forget rule No.1” – Warren Buffett
This is a very famous quote by Warren Buffet for investing in the stock market. But doesn’t that same quote apply to your business? You are investing money and time in your business and nurturing it from day one. With all the money invested, it is very important to keep a track of where the money is going and where the money will go; and budget planning is the most important activity you will undertake to protect your money and your business.
Whether you’re a CEO of a multi-million-dollar company or one man show running your own company, budgeting is the most important activity you must undertake every year. Updated financials and financial planning are instrumental in the success of any company, startup or a well-established business.
A targeted and well-worked plan will provide you the framework and guideline for the upcoming year. A budget helps to set revenue and customer/user targets for the next year, estimate all possible costs like your fixed cost (rent, salaries, loan payments), variable cost (cost of goods sold, customer acquisition cost)
A budget helps to set revenue and customer/user targets for the next year, estimate all possible costs like your fixed cost (rent, salaries, loan payments), variable cost (cost of goods sold, customer acquisition cost).
Some basic steps for budget planning would be:
Setting realistic sales targets
Sit with your senior sales team, take their perspective and ask them to set sales target they think they can achieve. This step will not only give you a realistic expectation of your topline but also set a guideline on how to allocate costs.
For example, next year your sales team is positive they can get another 1 lakh customers/users on board, or the company is planning to launch a new product/service. Estimate how much revenue your company can achieve from the new launch/ new customers.
Set up your expense plan
Based on the sales plan, you can now estimate how much you will need to spend to achieve the desired target. Look at the past trends for your expenses, and you can extrapolate the numbers if its business as usual; but if you do plan to take up new ventures, introduce new products/services in the upcoming year, there may be a requirement of relevant expenses.
For example, for the new product launch, there may a requirement of heavy expenditure in marketing or your sales team may have to travel all over the country to launch the product. This will increase your marketing and travel expenses significantly over the previous year.
Plan you hiring schedule
Yes, it is important to know if and when you will need to hire additional talent to help take your company to the next step.
For example, the company plans to launch a new product next year, where you estimate the sales to contribute to 20% of total sales; you may need new employees for your sales team or marketing team.
Plan major investments in assets
If you are an up and coming startup or any established business, there may always be a time where you need to invest in new technology, buy the requisite machinery, invest in laptops for your employees and sometimes even upgrade your office furniture. By listing all this down, you will know when and how much money will be required and also if your sales will help you with this cash requirement.
For example, if the company is involved in manufacturing, there may be a need of capacity expansion to meet the increased expectation in demand due to entering new geographies or for a new product launch. Or there may be a need to upgrade the old machineries/laptops due to wear and tear.
By planning this well in advance in your budget, you can estimate when and how much internal accruals you can use.
Draw up the cash flow
Once you have set the stage with the revenue and expenses, it is very important for any business to get a view on the cash flow over the upcoming year. Cash flow would shed light on your vendor payment cycles, users/customer payment cycles, cover all future investments in technology or any assets you need to purchase for your business, any loan repayments.
We have covered in one of our previous blog posts how cash mismanagement can lead to problems and with planning your budget, you can prevent them or at least be prepared and not blindsided by any sudden cash crunch.
Here’s a template to help you get started:
Types of Budget:
You can select the type of budget based on your company’s business model or requirement.
A fixed budget is a type of budget that remains unaltered regardless of changes in factors such as volume or variable costs. This budget is prepared mainly with assumptions.
Fixed budget is more suitable for companies that are static and execute a standard volume of production or business as usual.
Flexible budget changes as per the activity level carried out by the company. This budget is prepared with realistic situations in mind. This budget can be created for different levels of production or different users/customers levels.
Managers may need to accommodate unexpected changes with flexible budgets. For example, sales may be lower than originally expected, so the budget may need to reduce marketing expenditure and/or operational activities. An increase in orders may require additional recruitment costs for temporary staffing.
In a Zero budget, the company must start from zero every year and justify all planned expenses rather than using the previous year’s numbers as a base.
Here, the budget is built around what is needed for the upcoming year, regardless of the revenue or expenses of the previous year.
This budget helps you closely scrutinize of expenses in all your departments or see any changes in department cost when there is no significant increase in sales.
Simply put, a cash budget is an estimation of the cash position of the company in the future. By preparing a cash budget, the company can assess whether it will have enough cash to operate over the next period.
Once you draw up your budget, sit and review it holistically. But your job with the budget does not end there!
It is very important to review the budget at least once a quarter; and if you can review it monthly, even better. Get your accounts team to work to prepare your actual numbers and plot them against your budget. By doing this, you can shed light to any major deviations in the plan and can take the necessary steps to rectify the budget plan or readjust the expectations set in the budget.
You must make this an annual exercise and review the budget at the end of the year. And if you are doing the budget planning for the first time, you will have some numbers plotted somewhere for the last year’s expectations and see how well you did in achieving those numbers.
Remember, its all about financial discipline