When you hear the words budget, forecasts, or projections, you may see numbers flashing through your head, papers piling up, or formulas dancing in an electronic spreadsheet. In fact, creating a budget may involve all of these. The concept of budgeting is very simple. You have been budgeting money your whole life. Your first experience with budgeting was probably as a child when you planned a way to save enough money to buy your first bicycle, video game system, or roller blades.
A budget is an estimate of future numbers based on information you already know. Budgets estimate the profits, financial performance, and cash flow of a business for a particular period of time. Having and using a budget can help you:
- Evaluate operational efficiency.
- Monitor the financial health of your business.
- Assess managerial decisions.
- Plan the business’s financial future.
- Create a business that meets your financial goals.
The business planning process begins with budgets because every decision you make throughout this process—every change, every goal—affects financial outcomes. Budgeting is not an afterthought. Your budget is a reflection of the goals and strategies you have for each area of your business. The figures you budget for sales and expenses will help you chart your financial performance and compare your business’s actual performance against your goals.
Financial strategies flow from your company’s vision, mission, and business strategy. For example, when you develop a business strategy to grow your business within a specific market, you create certain financial expectations. You will probably forecast an increase in sales. In addition, your strategies may include increases in marketing expenses, payroll to produce the product/service, and capital equipment purchases. Developing a budget will help you plan for the costs of implementing these strategies.
Budget for Growth
Like many entrepreneurs, W. Michael Scott’s financial goals for Financial Management Solutions, Inc., (FMSI) were vague when he launched his company in 1990—he just wanted to be solvent. Yet as FMSI matured, specific financial goals began to emerge along with the need for a more formal budgeting process. FMSI hit its first financial milestone of $1 million in annual revenue in the mid-90s. Even so, a formal budgeting process didn’t surface for several more years.
That might sound surprising, especially for someone like Scott, who has a degree in business administration and established a successful fifteen-year track record in the banking industry before launching FMSI. Based in Alpharetta, Georgia, FMSI provides software that helps banks and financial institutions schedule tellers more efficiently and track productivity.
Establishing a formal budget for FMSI stemmed partly from growth. “When we were smaller, the numbers were in my head but not on paper,” Scott explains. “As other people came into the company, we had to become more sophisticated in documenting our financials.”
With no formal training on budget preparation, Scott developed his own financial tools, including an intensive spreadsheet with 103 line items that captures revenue and expenses in every area of the company. “Once we got the format down, budgeting became much easier,” Scott says.
Budgeting is not black and white, Scott stresses: “It’s an ongoing effort we revisit monthly because things change in our business.”
Accurate budgeting comes with experience, he adds: “To put something on paper you need to know what your environment is—which is difficult if you’re just starting out. It’s good to get coaching from other folks. If you form a board of advisers, try to get someone who might be a good resource at budgeting.”
Entrepreneurs and business managers use budgets to set financial goals and then to review actual performance against these goals. This regular review of the budget helps entrepreneurs get the business back on track without additional loss of time or money.
Sometimes budgets are prepared annually and not reviewed until the next budget cycle. This annual look at the budget is very ineffective in helping you reach your financial goals. It is like planning this season’s crops, planting the seeds, and then coming back at the end of the season to harvest what is there. Just as a farmer must fertilize, protect, and cultivate the crops, you need to attend and adjust the budget throughout the budget cycle.
Although some people consider the budget a simple list of planned expenses, useful budgets forecast profitability (sales and expenses) as well as the cash and capital equipment needed to support sales.
After completing this program, your budget will include estimates for these accounts:
- Operating Expenses
- Fixed Asset Purchases
- Cash needed and potential sources
These estimates will be projected on the following financial statements:
- Three-year projected Income Statements
- Three-year projected Balance Sheets
- Three-year projected Cash Flow Reports
Pumping up Profits
Michael Scott’s budget reflects FMSI’s aggressive sales growth and the costs associated with that strategy. He uses the budget to set specific goals for profits and then charts actual performance against the forecast. His financial strategy centers on increasing profits, not just sales. Because many of FMSI’s expenses are fixed, sales growth—both expanding existing accounts and wooing new clients—has the greatest impact on profits. In the past four years, FMSI’s annual revenue hovered between $2.5 and $3 million, which Michael Scott wants to double to about $6 million.
Scott believes that kind of growth is possible due to FMSI’s new product, Sales Management System™, which will enable the company to expand beyond banking to other industries, such as retail. He knows that the goal is bold. But he also feels that setting a big, daring goal helps employees stretch. “It gives your staff something to shoot for,” Scott says. “Start by saying something like, ‘Wouldn’t it be great if we could achieve X?’ Then people start thinking about ways to achieve X. Ideas come out of the woodwork, and plans begin to evolve to meet the goal.” Information technology has been a boon for FMSI. “In other industries, expanding sales might increase costs significantly,” explains Scott. “But in our business, we’ve been able to add a lot of technology that has enabled us to take on more clients without adding a lot of staff.” Increasing sales without increasing expenses is a sure way to improve profits.
© 2006 Ewing Marion Kauffman Foundation. All rights reserved.
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