In the modern world of running SME businesses, we often receive questions around budgeting and forecasting. These usually centre around how or when is the right time for a business to put these in place.
Many would say ‘it is never too early to plan. However, it may be useful to caveat that with caution around needing some credible reference points. The plans also need to benefit the business. I.e. if the business is changing so quickly such as an agile start-up, a full budget may not be easy to effectively manage. It is more efficient to consider certain KPI’s: sales targets, productive hours, cash collection or any number of easily measured markers that are significant in your business model.
1. Understanding budgeting
It is key to understand the nature of different costs the business incurs, so you can map to variations. These broadly fall into the following categories: –
Variable direct costs
Costs which change proportionately to revenue. Examples of these include:
- Unit costs of products providing revenue
- Increasing utility costs in line with production increase
- Bonuses to performance targets
These reflect costs that have a capacity threshold and consequently need to increase. Examples of these include:
- Office space will be fixed until you meet a certain staff number where additional space will be required. This can be partially mitigated by hybrid or remote working in service-based models but it is an evolving model.
- Production may be limited by other constraints such as machinery.
- Legacy computer systems may need further investment, such as storage or compute power or even software.
- Costs that remain static, or stable as the business grows. Examples include mortgage and rent payments, administrative salaries, insurance and depreciation.
With the above noted, and some simple formulae, you will be able to budget more accurately, and see the impacts of changes more readily. Linking variable direct costs to units of output, for example, and step costs to thresholds, say increasing every 100 units of output, will allow you to flex your budgets easily and even strength test them – often seen as estimated budget +/- 10%.
The use of software products has made forecasting more manageable and builds in the above examples of cost mapping, adding accuracy [although is limited by user inputs]. Investing the time to set up the reporting correctly is key, as this will impact on the management decisions, subject to accuracy.
Finally, three-way forecasting is the best way to monitor a business – this refers to a profit and loss, balance sheet and cash flow forecast. The first two reports are the fundamentals of business performance and value. However, the third, cash flow management is ultimately the benchmark by which a business can survive and see where cash may be needed in advance, which allows time for support through investment or lending to be arranged.
2. Identifying the best method for your business
People may discuss different methods of budgeting. This is less around the budget report itself, but the approach given to updating the report or allocating costs.
My general advice around forecasts is to try and keep the report as simple as possible, and understandable by the management team at all times. The complexity of the budget is largely led by the complexity of the business model, the number of service lines/products on offer and how these correlate to underlying costs.
As a business grows, the next step may be to divide the budget into areas where the responsible individual can exercise influence or control. Though it is still nice to see the complete picture at the board level. For instance, the head of a service line may have more benefit in seeing his revenue and costs in isolation, to focus on performance and delivery in that area.
A budget or forecast will change over the lifespan of a company. It may start simply around the income requirements of an individual founder. It should increase to a more corporate approach over 6 – 24 months.
3. Managing change in unprecedented times
We have seen more unexpected changes in the last 18 months than ever before. It has provided a constant reminder of the need to flex and adapt business models and budgets. Three key areas around change are:-
- The speed of change
- The scale of change
- The extent of control or influence over the change
All of the above interlink and make managing a business challenging and rewarding at the same time. It is important that if we didn’t have change then a lot of opportunities wouldn’t be available. Whilst the headlines are grabbed by the next billion-dollar company, SMEs are often the start of research, development and agile evolution.
The key to budgeting and business, in general, is to always be ready to adapt. Have confidence in the numbers, but trust in your business instinct.
In times of change, work on items that you have control over. We have all seen excellent examples of this in recent times – including restaurants offering take-away food, the use of digital collaboration tools, remote working and online sales. Whilst these may not have been the planned agenda, the results have been positive.
At times of challenge, keeping the business operational is often the sole aim, allowing advantage to be gained when normal trading conditions return. If you require support or advice around budgeting and cash flow, contact Sam Goodsell, Accounts and Advisory Director at Menzies on [email protected].
Menzies is a top 20 leading firm of accountants, finance and business advisors that operate out of a network of offices across Surrey, Hampshire and London, providing our clients with easy access and local knowledge. Described as the ‘best performing firm outside of the top 10’ by Accountancy Magazine, Menzies has over 400 employees and an annual turnover of more than £40m.