How Budgets Will Help Your Small Business Thrive

I often hear “Budgets are never right, so what’s the point in creating them?” Of course, they aren’t but that shouldn’t put you off! They are based on assumptions and we all know that “sh*t happens”. “Good as well as bad sh*t”. So if your underlying assumptions are different to what actually happens your budget will be “wrong”! But if you know what those assumptions are (your key drivers) and you track performance by those key drivers you are in a much better position to take corrective action (or push a driver or leaver harder if it’s working for you).

The point I want to make for small businesses is the very act of planning and regularly comparing progress against that plan helps you to know if you are on track to meeting your goals. If you budget well and track the key drivers underpinning that budget, you will also understand what is driving the difference between your actual performance and your budget.

This will help you to make better decisions throughout the year as opposed to waiting to find out you haven’t done as well as you thought and it’s too late to put it right!

As we enter Q4 of 2023, many are casting their eyes towards to 2024. It’s a great time to think about your budget for next year.

How budgets will support small business growth

1. Apart from tracking your progress on a regular basis, having a budget is a useful tool in helping you to truly understand the financial health of your business. It takes your current performance and helps you to understand your cashflows and funding requirements for the next 12 months.
2. Budgets will help you and your management team, make better decisions based on current information and the likely financial position of your business over the next 12 months.

Why a budget is important for a small business

Small growing businesses often have limited resources to support that growth. It may be cash, or it may be people or specific equipment.

A budget will help the team to think through the best use of those limited resources to get the best short and longer-term returns. It will also help them to plan for future cash requirements so that they can make sure they don’t leave it to the last minute to find the funding they need.

One of the advantages small businesses have is agility. This helps them to act quickly and change course if they need to, much quicker than larger conglomerates. Keeping track of your financial performance on a monthly basis will enhance that agility and your ability to quickly make more informed decisions.

For example, if part of your process for building your budget includes scenario planning, you will have the opportunity to see what could happen from a financial perspective if for example you lost some of your key people. It enables you to think through in advance, the decisions you might have to make quickly if you are faced with this challenge.

Tips for preparing a budget for a small business

1. Start with what you know is true. This means a clear understanding of your current financial position. For example, it’s no good preparing a budget which assumes you will start 2024 with 50 clients if you only have 10 now and no clear plan on how to fill the missing gap before 1^st If you do this, you will always be playing catch up because you will be behind budget before you start!
2. Understanding your starting point is also key to preparing a good cashflow forecast from your budget. If your clients are currently taking 60 days to pay your bills, your projected cashflow could be significantly different to the reality you experience if you are assuming everyone pays in 30 days when you prepare your cashflow. I know this may seem obvious, but I’m trying to labour the point of really understanding the financial health of your business now which will impact some of the key drivers underpinning your budget.

Four budgeting methods for a small business

When selecting a budgeting method for your small business, consider your specific business needs, industry, and growth stage.

1. Incremental Budgeting

Incremental budgeting is a traditional budgeting method where a business takes its current years performance as a base and makes incremental adjustments for the upcoming year. Small business owners using this method typically make changes based on expected inflation, growth, and other factors. In practice, this means you add  X% to this years performance. This method is relatively simple, and you may find it works for your business with consistent and predictable revenue and expenses. However, it may not encourage a thorough review of spending or resource allocation.

2. Activity-Based Budgeting

Activity-based budgeting focuses on the specific activities and tasks that contribute to a business’s goals. Small business owners using this method identify key activities and allocate resources based on the cost and value of each activity. This approach allows for a more detailed analysis of expenses and a better understanding of how resources are used. It is particularly useful for businesses with diverse operations or those looking to maximise their resource allocation.

3. Value Proposition Budgeting

Value proposition budgeting places a strong emphasis on aligning the budget with the value a business provides to its customers. Small business owners using this method identify the core elements that make their products or services valuable to customers and allocate resources accordingly. This approach ensures that budget decisions are closely tied to customer satisfaction and business profitability. It can be especially beneficial for businesses aiming to differentiate themselves in a competitive market.

4. Zero-Based Budgeting

Zero-based budgeting requires small business owners to justify all expenses from a zero base or a starting point of zero pounds. Each expense item needs to be justified, reviewed, and approved, which can lead to a more cost-conscious and efficient budget. While it requires more effort and scrutiny, it can help eliminate unnecessary expenses and ensure that every expense serves a specific purpose. This approach is valuable for businesses looking to cut costs or adapt to changing economic conditions.

You may find that using a combination of these budgeting methods works best for your small business to thrive. You may apply a different method to different sections of your business.

Have a chat to us if you’re unclear. Our part-time FDs can work with you to create a budget that’s right for your business.

What to include in your small business budget

I would always recommend a ‘3-way Budget’. This means looking at a Budgeted Balance Sheet, and Cashflow as well as just your costs or your Profit and Loss. You will probably need some help from a finance professional to do this, but the added clarity on your projected cashflow will be worth its weight in gold.

I’d also recommend really understanding some of your key drivers e.g., client numbers can be broken down into existing clients, new clients and churn rate. If you have clear assumptions on this, and you are able to track this, then it will help you understand if you have a new business problem or a retention problem – or even better no problem at all!!

Potential budget pitfalls

1. Budgets can be a stressful time.
2. Ensure you are realistic with your predictions.
3. Overcomplicating budgets – sweating over a massive spreadsheet you don’t really understand. You’re just wasting your time better spent elsewhere and builds frustration.
4. Don’t underestimate the importance of a reality check-in – understand if the answer makes sense. If you now have a budget which predicts profit of X and cashflows of Y, don’t forget to stand back and ask yourself ‘does this makes sense?’
5. Remember to review regularly and adjust your budget by re-forecasting to keep your business financially healthy and adaptable to changing circumstances.
6. Keep your budget alive. If you get halfway through the year and you lose a key customer this will have a major impact on your performance. Any comparisons against your original budget will be pointless. I recommend re-forecasting after any major event like this or at least at the half year to you can improve your projections.

Track, re-forecast and revisit!

A summary of advantages of business budgeting

1. The ability to evaluate opportunities using scenario planning
2. Supports decision-making for senior managers.
3. Creates resilience for long-term growth, by insuring you know what your cash requirements will be.
4. Reduces risk to your business because you can put in place plans to mitigate those risks.
5. Having a target to aim for can increase in performance of your business and your leadership team.
6. Those targets will filters down your managers to encourage ownership and responsibility.

Reduce your stress and increase your opportunities

Don’t miss out on the many advantages of having a budget for your business. If you don’t know where to start or need help to create a realistic, 3 way budget for your small business, our part time FDs are here to help you. We would be happy to discuss this as a one-off piece of work or even better join us as an ongoing going client and see what a difference we can make to your leadership team on a regular basis.