If December is your year-end, it is now time to develop a budget for your next fiscal year. A budget is not that difficult to do and is there to help guide you, not to constrain you and your business. An actual budget does not just look at your income statement, but also on your balance sheet.
If you have been in business for at least 2-3 years, you should have a run rate and understanding of your annual growth each year. Forecasting not only looks at your prior years and seasonality, but also should look at the plans you have in place for generating new or increased revenue next year, which could include a new product, new pricing, or a new channel to market. The forecast should also include any expected income from customers in the new year.
Cost of Goods
Depending on your business, your cost of goods sold is most likely going to increase which includes raw materials, labour, and inbound shipping associated with selling the finished product to the end customer. It is vital to plan for this as it will affect your margin.
To budget for your expenses, you will need to have an understanding of the changes that will occur within your costs in the next year and see how this will affect your bottom line. With the changes in the minimum wage, your payroll expenses are going to increase. Once you have completed your marketing budget, this should be input into the expense line as well, along with any other changes such as increases in rent, utilities, or insurance for example. You will need to account for any new headcount or expenses that you may plan to spend this year versus previous years such as travel.
Balance Sheet Items
If you are developing a budget, you have to look at your balance sheet as well as your income statement items. Here is a list of a few items on your balance sheet that need to be planned for and have an understanding of how this affects your cash flow monthly.
One of the main reasons many of our clients contact us initially is to gain a better understanding of their financials and what they are telling them. One of the best ways to do that is to start with the budgeting process as it provides you with an understanding of your revenue, your cost of goods, (it also helps you understand what drives costs in your organization) and your operating expenses. If you are a start-up business, the process is a little tougher as you do not have existing financials and an existing run rate to rely on.
Benefits of Budgeting for your Business
Budgeting allows you to:
Before you start the budgeting process for your business, it is a good idea that you have your Chart of Accounts set up properly that reflects your operations. If you are working off a default chart of accounts for your business that you were not involved in with your bookkeeper or accountant, now is a good time to sit down with someone and modify this before you get started. To set up a chart of accounts properly for a business, you need to understand the business.
Every business will differ on how your revenue is broken out. If you have multiple products or service types or other forms of revenue that you want to have an understanding of how each is performing, you will want to break those out separately. It could be as easy as Products, Services, Subcontracting, and Interest Income. If you want to have sub-categories, that is perfectly fine as well.
Cost of Sales
Depending on your business your cost of sales (COS) will differ, so you may want to break out your cost of sales so that you can track it as it directly relates to the revenue that it is associated.
The cost of goods sold (COGS) are part of the cost of sales and are those direct costs that are tied to the production of goods sold by the company such as the cost of materials and any direct labor costs to produce the goods. The cost of goods are included in the overall cost of sales. If you are a manufacturing business or a retail business that buys products and inventories them, you have cost of goods sold (COGS). If you are a services business, you will not have the cost of goods sold, but you may have a cost of sales (COS). The cost of sales items could include commissions, shipping and delivery, and any other expenses that are related to selling.
Be sure to discuss this with your accountant, so you understand what is relevant for your business.
There are many operating expenses that are the same for every business, but there will be some expenses that relate to your business. You also have to understand if they are paid every month or are paid once a year and know when they are paid. The level of detail for your operating expenses depends on how you best want to track various expenses and delve into them. For example, You might have Wages, but you probably want to break out salaried employees from hourly employees along with the relevant taxes and even commissions. It is all very dependent on the level of detail you want to understand about your business.
Once you have the Chart of Accounts set up for how you want to run your business, you are ready to start.
The Budgeting Process
Step 1 – Historical Data
As mentioned earlier, if you are an existing business you can run a profit and loss statement from your accounting system to provide you with some historical data, especially for operating costs that remain approximately the same, such as utilities or telephone. You will also have an understanding of last year’s revenues and cost of goods as well. If you are in a seasonal business, you will be able to see how the seasonality affects your net income. If you are a start-up, then you are starting at ground zero and is important to understand your business enough to forecast revenues, understand your cost of goods, and know approximately what your operating costs will be for the first year by month.
Step 2 – Set Realistic Revenue Targets
If you are looking to increase your revenue, be sure to set realistic targets. As you are setting those targets, you need to understand what costs will increase to make that revenue, whether they are the cost of goods, outbound shipping, or even marketing. If the increasing volume decreases your cost of goods, then you need to understand the correlation when you set up your budget.
Step 3 – Make Sure Right People Are Involved
If you have departments or individuals in your business who have the authority to spend money, you will want to make sure they are involved in the budgeting process. If you have a sales manager in your business who is responsible for sales, they need also to be part of the helping you budget your revenue. Larger businesses who have departments with managers should have each manager develop a budget that they provide to develop the company’s budget. The owner has the final say, but getting input from others can help with accuracy.
Step 4 – Establish the Budget
There are two ways to create a budget; 1) use last years numbers and increase expenses for inflation and sales growth, or 2) Bottom-up budget, (also known as zero-based-budgeting) where every dollar spent is scrutinized and justified based on the sales volumes that are anticipated (forecasted). Bottom-up will provide an owner with the most useful and relevant information and plan, however; it does take more time and effort. If your profits vary unpredictably, bottom-up budgeting is a good process to follow to gain betting insight.
Step 5– Enter Your Actuals at the End of the Month
If you are not using an Accounting System with a Budgeting Module, you want to make sure to enter your actuals for each month next to your budgeted amounts
Step 6 – Measure Your Performance
You want to make sure to calculate the variance (the difference) between your budget and your actuals for each month, quarter, and year. How are you performing to your budget? Are your expenses more than you expected and if they are, do you know why?
Step 7 – Review Your Budget and Revise It As Required
You may need to revise your budget if you suddenly find there are large variances between your actuals and your budget. You may have overestimated your revenues and need to go back and edit the budgeted revenues to be more representative. Some businesses keep a budget (because it was board approved) and they create an ‘outlook’ which provides the same information. This way you can see how actual, outlook and budget compare with each other.
If you budget and measure the variance to the actuals for your business, you will begin to get a better handle on how your business is performing and what is affecting your cash flow on a monthly basis. There are only two ways to improve your cash flow position in your business. One is increasing revenues, and the other is reducing expenses. Having a budget to guide you will help you to make more informed financial decisions for your business.
Budgeting is not meant to be confining, and budgets can be modified. If you need to increase your online advertising to increase revenue but you had not budgeted for this, you also need to increase the revenue in the budget as well. Once your actuals come in, you will be able to see if that spend actually helped you in meeting your revenue goal.
As we look ahead, we have asked visitors to our website where their areas of focus will be this year. Though there have been varied responses, at the end of the day, every business is looking to improve their bottom line. With this in mind, we have chosen to provide an article to help that focuses on five different ways to accomplish this task.This article is longer than most, so we have provided this one article to provide support to business owners looking ahead.
Increase Working Capital and Improve Cash Flow
To increase your working capital in your business and improve your cash flow, you need to have a good handle on your financials. Cash is "King", so it is important to be able to manage correctly the financials outlined below with relationship to your business.
What is in your bank account is not what is available to spend and if this is something you do, it can have serious repercussions if you do not know what receivables are outstanding and what payables are due. If you have to pick and choose who to pay each month, this means you are not generating enough cash to cover your expenses. In this case, your only option is to reduce expenses and / or increase revenue. Here are some tips in order to improve your cash flow that will in time increase your working capital.
Productivity is defined as the good output measures with respect to inputs supplied. In the case of employees Productivity rate = hours billable/hours paid. If you find you are paying your employees for more hours than you can charge out for in labour - this is a problem. A business that is functioning at over 75% is good, if you are under 50%, this is a problem area. This is especially true in services and labour intensive industries such as manufacturing. Here are some areas to look at in your business.
Code Your Transactions Properly
Most business owners do not consider how their transactions are coded in their financial system, such as QuickBooks. This is where paying for an experienced bookkeeper and involving your accountant in your business can save you money in the long run. Here are some tips to keep in mind to keep more money in your pocket instead of CRA.
Pay Your Taxes When They Are Due
There are three levels of taxation for a business which include Income Tax or Corporate Tax depending on the business type, HST for Provinces that have harmonized Tax, and Payroll Taxes. In some Provinces, there will be PST and GST instead of Harmonized Tax. Most businesses and business owners that in trouble with CRA, for the most part, is usually due to non-payment of HST (or PST/GST equivalent) or Payroll Taxes, as these taxes are paid on a monthly basis. For these taxes, you are acting as an agent of the government, and the cash you collect belongs to CRA. Here are some points to keep in mind moving forward.
Many times we here from business owners that they believe a budget is constraining and will not allow them to spend. We are of the opinion, instead, that it will set you free. If you do not have a budget, how can you figure out what is going on in your business if you have nothing to compare it to, as we do not find many business owners that look at their profit and loss in detail on a monthly basis. If you have a budget, and things are going well in your business, it will help you maximize your opportunities. If you do not earn the profit expected, it will allow you to zero in on the specific line item that is out of line rather than reviewing transactions in detail. A budget will help you manage your business appropriately instead of worrying about whether you have the money to spend on items such as marketing to generate more sales.
We hope this article helps provide you some guidance in looking forward and provides points you can use in your business to help you improve the bottom line in your business.
RK Fischer & Associates