How to create a budget for your business?

In today’s blog, here at Tulip Thistle Accountancy, and as a follow up to my recent blog on how to increase your business’ profit and Cash Flow, today’s topic is how to create a budget or financial plan for your business.

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Every business whether small or large, should create a financial plan. Level of detail (and time horizon) will depend on size and complexity of the business but the main objectives remain the same:

1. translate business objectives into financial targets

2. create a baseline against which Actual performance can be judged

3. identify capacity constraints (machinery, people, process)

4. manage the limited resources of the business so that they are focused on activities which support business objectives

5. articulate the Key Performance Indicators which demonstrate the health of your business

Business Objectives

Are you clear on what you want your business to achieve in the next quarter or year? Objectives work best if they are SMART (Specific, Measurable, Realist and Time-bound). Here are some examples:

1. increase business profit by 10% next year

2. double my number of clients next quarter

3. increase productivity by 50% next financial year. Rather than it taking 10 working hours to deliver my consultancy product, I want to do it in 5 hours instead

4. improve customer service. Reduce customer complaints by 10% versus last year

5. spend £1,000 of business income next year on charity donations

6. generate £50,000 of Cash Flow to invest in new machinery or technology next year to boost our capacity

Let’s take a close look at business objective 1  above. On it’s own this goal won’t be enough; you will need to identify how to deliver a 10% profit increase and as the table with worked example below shows, this can be achieved in different ways

  1. increase sales by +7% (maintain margin of 30%).
  2. if able to increase your margin to 35%, sales can actually reduce by -9%
  3. increase sales by +28% (drop margin to 25%)
  4. reduce your overhead costs (e.g. rents, rates, insurances, administration) by -20%
£’000 Last Year Same margin Increase margin Reduce  margin Reduce O/Heads
Sales 500 533 457 640 500
Cost of Sales (350) (373) (297) (480) (350)
Margin 150 160 160 160 150
Overheads (50) (50) (50) (50) (40)
Profit before Tax 100 110 110 110 110
Margin as % sales 30% 30% 35% 25% 30%
Admin as % sales 10% 9.4% 10.9% 7.8% 8%

Overlaying your knowledge of your market place & customers, you will be able to come up with an approach to achieve your business objective of 10% profit increase.

Specific actions may be needed to achieve cost reductions. Monitoring progress with milestones will ensure you know whether you are on track, or give you an early warning when you are not making progress as planned. So if you are not able to achieve the planned cost reduction, you may be able to set a revised sales target to still hit the 10% profit increase you want to achieve.

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You don’t necessarily need accounting software to create a budget and in many ways at the budget creation stage you are often well served using Microsoft Excel. However once you have set your budget, tracking progress against it becomes significantly easier to do if you use the budgeting modules in Cloud Accounting Software such as QuickBooks or Xero. That way at the end of each month you can easily see the progress made against the targets & take corrective action if required.

To help you set a meaningful budget, it helps to draw on your an in-depth understanding of your business.

Important information to have available when setting budgets:

  • product profitability
  • customer profitability
  • competitors & overall market you are working in
  • good understanding of your cost base
  • capacity constraints. For example it is no good chasing an 20% sales growth if with the current machinery in place you are already at full capacity. If sales potential is available, it may lead you you to assess whether investment in new capacity is viable
  • ensure you understand external constraints (e.g. changes in labour costs due to changes in minimum wage, additional pension contributions, new industry specific or general regulations etc.)

Key Performance Indicators

Once you have created a budget, you can identify certain key measures which you need to keep an eye on an check regularly, to make sure you deliver the plan. These Key Performance Indicators can be reviewed on a daily, weekly or monthly basis as required. For example Michael Welch, the founder of Blackcircles.com, used to review sales data daily & would take corrective action using promotion & other pricing tools as required.  Again having a Cloud Accounting Software package will simplify this task significantly.

If you need some professional advice setting up a budget for your business, let us know and here at Tulip Thistle Accountancy we would be happy to help.

Until the next time!

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Charles Donkers (ACMA), Tulip Thistle Accountancy

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