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A budget is a roadmap for a business to achieve financial stability by planning, reviewing, and updating its revenue and expense streams. Budgets let you track your results against targets and plan and execute timely course corrections.
Trying to run any business, even a startup, without a sound and well-planned budget is skating on thin ice.
That said, there are some common budgeting mistakes that you should avoid. Let’s look at seven.
1. Overestimating sales
The worst way to set sales targets is to look at last year's performance and tag on a “reasonable” growth percentage. If you want to set realistic targets that aren’t consistently under or overachieved, you need to look at more than just last year's performance. You need to factor in variables like market size and dynamics, competition, expansion into new geographies, etc.
The sales target is a goal, and like all goals, it needs to be S.M.A.R.T. The target needs to be specific, measurable, achievable, realistic, and time-bound. Today, almost all sales software allows you to combine past performance, rep performance, market growth, and business foresight into one cohesive and achievable target.
Another way to set your sales target is on a rolling forecast. This approach makes forecasting a process of performance evaluation, it involves evaluating the last quarter and then setting the budget for the next. After all, if the economy, market, and customer needs aren’t static, why should your budget be so?
2. Not basing the budget on data
An accurate budget is based on hard data, not guesstimates or gut feel. The first thing you need to look at is if your budget is going to be top-down or are you going for bottom-up budgeting. In top-down budgeting, you start by defining sales and then define the expenses you will incur to meet that sales target. Bottom-up budgeting reverses the process.
Next, review your previous year’s budget to identify areas where you had expense overruns and revenue shortfalls. Identify the reasons and implement strategies to eliminate these events. This will help in pointing you towards more accurate numbers for your next year’s budget.
But don’t just base your numbers on last year’s budget alone. Look at things like the overall business environment and market trends to identify areas where your expense or revenue would change from last year.
Let’s say you run a printing company, and paper prices have risen 15% over the last year. Apart from taking this rise into account of your raw material cost, you also need to figure out if this trend will continue into the following year.
Here’s a pro tip: Start by defining your projected sales and then identify your fixed and variable expenses. Now, look at how you did against your budgeted number last year. Think of operational changes that could impact these numbers. For instance, launching a new product would open a new revenue stream but would also increase development and marketing costs.
3. Not tracking your revenue and expenses
It’s all well and good to make an accurate and well-planned budget, but are you monitoring your performance regularly against this budget? That’s one of the biggest budgeting mistakes you can make. If you don’t do this, you could be in for some nasty surprises. Tracking funds that flow in and out of your company is critical to making sound business decisions. A failure to monitor your budget is even a more enormous blunder than not making a budget.
A periodic review of your budget numbers helps you identify underperforming revenue streams and expense heads where you’re spending more than you should. The review allows you to take corrective action in time. For instance, if a product is underperforming in sales, you can identify and fix the reasons.
Some basic steps you should take to monitor your budget include:
Choose an appropriate accounting system
Connect your financial institutions
Record all your expenses
Consider using an expense management app
Accounting automation platforms help you create and manage your budget and expenses.
Source: Bench.co
You can simplify tracking expenses at small businesses by simply connecting the financial institutions you use with your accounting software. While many small businesses are hesitant to connect their accounting packages to the banks they use, in practice, it is a safe and reliable way to monitor your expenses. The financial institutions have inbuilt protection that keeps your data safe.
Connecting your business to your bank lets you download all banking transactions directly to your accounting software. In many cases, the data will be directly posted to the appropriate account, thus making it easy to monitor your expenses.
Business budgeting tools like Spendesk enable you to simplify creating and managing your budget. Look at the flowchart below:
Expense management apps enable you to review your budget in real-time while automating the process of making error-prone manual entries.
4. Not budgeting for unexpected expenses
Businesses operate in a dynamic environment and will, hence, run into situations that call for unexpected and unbudgeted expenses. Then, not budgeting for unexpected expenses is another one of those budgeting mistakes you should avoid. Allocating an emergency fund in your budget for these expenses enables you to handle them without disrupting your financial stability. The emergency fund should be about 5% of your budgeted expenses as a general thumb rule.
The emergency fund is your safety net when your vendor raises prices due to an increase in raw material prices. Not allocating for unexpected expenses means you will cover them with either debt or liquidating your assets. An emergency fund enables you to draw from the fund when needed. Then you can replenish the draw from your earnings.
Another way to do this is to create the fund with a fixed allocation and then add a small allocation to it every month from your sales. That will help grow the emergency fund in the months you don’t use it, and the unused allocation works like an added saving and investment.
5. Setting unrealistic goals
Remember what we said about S.M.A.R.T. goals earlier? Well, the fact remains that many companies overestimate sales and underestimate expenses during the budgetary process. Budgeting for a 25% YOY growth in a market growing at 5% is calling for trouble unless you have a marginal market share, are planning to introduce a new product, or enter a new niche.
The flip side of setting unrealistic sales targets is underestimating your expenses. Although fixed expenses like rent and salaries can be projected accurately, variable expenses like the cost of goods or marketing expenses can fluctuate from last year’s numbers. While budgeting for expenses, it’s always better to be prudent rather than optimistic. Another way to keep expenses under control is to always look for ways to see if you can do things for less. Let’s say you’re buying all your products from one vendor. Look for another vendor who can supply the same product.
By introducing competition into your supply chain, you will make the two vendors compete for your business and get lower prices. Alternatively, let’s say you’re planning to grow your business by 25% this year. Re-visit prices with all your suppliers and ask for discounts based on higher volumes.
The objective is to set realistic goals and then look for ways to enhance sales while reducing expenses. That will go a long way towards meeting or improving your budgetary targets. It will keep your business in good financial health.
6. Not updating the budget
By now, we know the importance of creating and monitoring the budget for your business. A part of the review process is also to update the budget periodically. Your budget is dynamic and should change based on your periodic reviews.
Let’s say your raw material prices go up by 5%, while your budget was based on previous prices. It now makes sense to increase the allocation to this expense by 5% going forward in your budget.
Or let’s say competitive pressure forces you to reduce your prices by 5% for the foreseeable future, it’s now prudent to look at your sales revenue and decide if you want to cut sales by 5% or increase the unit sales by the same amount.
The whole idea is to have clear budgeting reports that accurately reflect the health of your business.
7. Not sharing the budget with relevant stakeholders
The final step in your budgetary process is to share it with all relevant stakeholders. That will give them guidelines within which they must operate and what’s required of them. Your business operates with multiple teams across different business verticals. The team leads or the heads of a vertical (think operations, sales, marketing, and so on) should have a copy of the budget that defines the expectations in terms of revenue and expenses for that vertical.
The budget also defines how much each team or vertical can spend during the year and to whom they need to report the expenses. It empowers each team member to monitor the budgetary allocation actively. Ask yourself two questions, first, is everyone aware of how much they can spend, and on what? And secondly, does everyone know how to report their spending on a monthly basis?
Unless you can answer “yes” to both these questions, you haven’t shared the budget fully with your internal teams. Without complete sharing, you’re also likely to struggle while trying to track and measure the effectiveness of your budget.
Last but not least, you also need to look at the messaging. You need to communicate the importance of following and reporting on your budget with your internal audience, it makes sense to get your communication right.
Wrapping up
The fact is that there are very few business or startup owners who enjoy creating budgets, finances, and spreadsheets. Creating budgets is simply not why they got into business in the first place.
However, accurate budgeting is an integral part of ensuring the financial health of a business. Hence, knowing the pitfalls to avoid while budgeting is a step in the right direction.
Overestimating sales, not basing the budget on data, not tracking your revenue and expenses, and not budgeting for unexpected expenses are definite no-nos. Setting unrealistic goals, not updating the budget, and not sharing it with relevant stakeholders are something to avoid, too.
If you want to succeed as a business, you need to create and monitor your budget as short-term pain for long-term gain.
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