Updated: Oct 6, 2022
By James Lanning
#1 Financial planning
The word “budget” sometimes has a negative connotation. If you’re on a budget, it often means that you are restricted to a certain level of spending or that you are bound by certain parameters. And while this is often the case, it really makes sense to shift that thinking and consider your budget as the financial plan for your business. Everyone understands planning, its importance, and how it can really help you stay the course. A budget is essentially the financial implications of that plan.
A financial plan will help you answer key questions:
What expenses will I incur monthly?
How many units of product or hours of service do I need to sell to break even?
How many employees should I hire?
Operating a business without a financial plan or budget is like going to the grocery store without a list. We have all done it before, and when we do, we often end up spending money on things we didn’t need or forget to buy the things we do.
#2 Goal setting
Setting your goals at the beginning of the year will increase the likelihood of achieving them. A budget or financial plan will do the same for your financial goals. If your goal is to earn a profit at the end of the year, then you need to ensure your budget reflects that. A budget forces you to map out your goals, save your money, keep track of your progress, and plan for the future. If your goal is to expand your business to a new region in two years, then you will need to start planning for that today; you can do so by ensuring that you are building room in your budget to accumulate cash to invest in this growth.
#3 Tracking progress
Having a budget in place allows you to measure the performance of your business against that budget and adjust throughout the year if you start to veer off course.
Only what gets measured gets managed. If you can easily track the performance of your organization, you will make sure to manage your resources in a way that helps you achieve your financial goals. In the accounting and finance world, you will often hear it called a budget-to-actuals report or a variance analysis, but essentially it is just measuring how your business actually performed against how you expected it to perform. After identifying any major differences, you can dig in deeper to understand the cause and make decisions to correct it.
#4 Seeing the full picture
Too often, new business owners do not consider the full financial scope of their business. Entrepreneurs can get excited about the prospect of revenue and making sales but forget to consider the full cost of doing business. This leads to an overly optimistic outlook on the profitability of their business or project and can lead to incorrect pricing of the service or product. Creating a budget enables business owners to fully understand the cost of running their business.
Identifying the revenues and direct costs related to selling your product or service is usually straightforward. For example, if you’re selling widgets for $100 and they cost you $50 to buy, then you will profit $50 on each widget sold, right? Wrong.
A lot of new business owners completely forget to factor in the indirect or overhead costs of running a business. Expenses such as interest and bank fees, insurance, taxes, licences, and subscriptions are commonly overlooked. These expenses need to be considered when you price your product or service, and including them will allow you to accurately plan sales targets in the future.
#5 Taking control
If you are losing sleep at night worrying about how you are going to pay the bills, you are letting your finances control you instead of controlling your finances. Building a budget and continually monitoring your business’s performance against it can expose bad spending habits of your organization. Most business owners often underestimate the amount of money they spend on things they don’t necessarily need. Even when situations arise that are out of your control (for example, a global pandemic), a solid financial plan should include contingencies for periods of time where cash flow may not be as strong as expected. If your business relies on seasonal revenue, you need to plan for the months when revenues are not strong and save money to pay the bills during these periods. Examining your financials and planning appropriately for these moments will allow you to get a better night’s sleep.
James Lanning has more than seven years of experience working in positions ranging from financial controller to director of operations. He graduated with a BComm in 2014 and received his CPA designation in 2017 and a Certificate in Project Management in 2018. In addition, he completed the Oxford Strategic Innovation Programme in 2021. A perpetual learner, James is keen to help entrepreneurs grow their businesses by providing accurate, timely, and consistent financial information.