Very few small to mid size businesses actually utilize a budget. I will discuss how to build a realistic budget for your business. A budget is truly meant to be a living document that represents the most realistic set of expectations that the business can plan on based on the facts on the ground – in the business. Instead, what we do is create an annual budget, then maybe (mostly informally) update it. Then we look back at the end of the year and wonder what went wrong?
"Budgets! We don't need no stinking budgets!" Depending on your age, you will recognize the gist of this quote from either the classic Bogart file "Treasure of the Sierra Madre" or the Brooks classic "Blazing Saddles."
It is an appropriate quote though as I find that many business owners don't actually do a budget for their business, let alone their household, and thus fly by the seat of their pants. Those that do develop a budget often confuse a budget with a goal – meaning that they will create a sales 'budget' that is actually a sales goal, and model a P&L and balance sheet against this.
As I was in the process of pulling together our annual budget (as we have historically fallen in the 'have a budget, but don't update it more than 1X per year camp) I happened upon a great article in the October 2011 Journal of Accountancy on budgeting – Planning for Uncertainty – that advocates updating budgets much more frequently than once per year based on attributes that are both variable and volatile in your business. The example that the article uses is Southwest Airlines (outperforms peer airlines by the way) – Southwest updates its budgets daily for things like revenue and cash, and weekly for things like fuel costs due to volatility in the market for fuel. In my business, my marketing budget is somewhat variable based on anticipated cash collections, and how much I spend on salaries is variable based on new business I bring in so my 'D'uh' moment is that 'of course I should be updating my budget more frequently.' So now I have a budget, following the guidelines in the article, that is rolling in nature and is based on reality, not my goals, hopes, and desires. Now, we still have a revenue goal, but we're not making spending decisions based on the revenue goal, rather they are based on the budget.
So, how do you actually develop a budget? Well, history is always good. I'd start with major accounts (e.g. marketing) and have sub budgets that correspond to actual spend. I would look at historic revenue patterns, backlog, historic customer spend, etc. based on the nature of your business. Based on this, you can develop a realistic 12 month budget. So – now you will tell me 'but Adam – I need to do better than that!' Well, that's where goal setting comes in. I think you can set a goal based on several criteria – my own personal favorite is to start with a bottom line profit goal that either meets your personal requirements, debt reduction requirements, or wealth building requirements, then build a sales goal from that. See post on determining sales goals. But I wouldn't start spending money according to the goal UNTIL you see that you are actually hitting your goals. For example, if your budgeted history for sales in January is $1,000,000 and your sales goal is $1,500,000 – if you don't feel good about your ability to hit your goal (e.g. pipeline analysis, order backlog, growth you've seen in prior months) then you should budget for what you really expect and spend accordingly. This will help you make more informed decisions and will, hopefully, lead to a healthy bottom line and balance sheet.
