I have a secret to share with you. Your monthly financials don’t really tell you what you think they do. Most business owners think their financials tell them how much in sales, expenses, and profit or loss they experienced. In reality, your financials are a numerical representation of your habits as a business owner – good and bad habits.
Budgets are similar – a budget is a numerical representation of your future habits. Budgets are planning tools used to help businesses see the impact of certain decisions and layout what you as the business owner will do and have those you work with do.
With that in mind, let’s look at five simple steps to setup a budget for your business.
Step One: Look at your Revenue Sources.
Take a look at your monthly sales and revenue amounts over the past twelve months. Where does your revenue come from? What are the drivers. After that examination, ask yourself what habits you have that gave you the results you have over the past twelve months. Then ask what you are going to change and what you are going to keep? What will those habit changes do to your future revenue?
After this thought exercise and deep dive into your habits, go ahead and map out what your sales will look like over the next twelve months. Somethings might stay similar to the last twelve months while the impact of habits will increase or decrease some sources of revenue while new sources may be added and old ones removed as a result of your habit changes.
You should now have 24 months of revenue before you – twelve historical and twelve future. Whether or not you realize those future twelve will be a result of the habits you do during those twelve months.
Step Two: Look at your Fixed Costs
Expenses or costs are broken into two categories – Fixed and Variable Costs.
Henry David Thoreau said, “The cost of a thing is the amount of what I will call life which is required to be exchanged for it, immediately or in the long run.” This definition ties nicely to the idea of your financials being a representation of your habits. There are rewards and costs for each of our habits.
Fixed costs are those that don’t really change much each month. Ask yourself, “If our revenue went up or down, what expenses would stay the same?” These are your fixed costs. There may be some fluctuation month to month and you may have inflationary increases in the numbers but these expenses should be the easy ones to predict.
After identifying the fixed costs, examine the past and then predict the impact of your future habits on these costs. You may need a bigger building, office or warehouse as a result of your future habits and these costs should be added to the budget. You may decide to tighten your belt and find less expensive accommodations for your business as a result of a habit change. Fixed costs may not change much from month to month but they can be changed.
Map out the future twelve months of fixed costs.
Step Three: Look at your Variable Costs
Variable costs are those that change as a result of your revenue. These are expenses that will vary with your revenue. If you sell another widget, you incur costs to make, buy, or sell the product.
Look at your historical variable costs and then think about how your future habits will have an impact on them. If you establish habits to grow sales, you will have increased variable costs. Keep in mind that not all variable costs are necessary and you can also examine where you have spent that you don’t need to. You may still choose to make those expenses though.
Map out the future twelve months of these variable costs.
Step Four: Plan for One-Time Items
You may know of a one-time project that will increase your revenue and expenses for a short period of time. You may know that you will need to purchase equipment that you will only buy once. What one-time costs and revenue will you experience as a result of your habits in the next twelve months?
Map out these one-time items and their timing.
Step Five: The Big Picture
It is now time to put it all together and look at the big picture. How does your future twelve months compare to the past? What habits do you have to have to reach these results? Does the budget represent your plans and habits?
If so, get to work. If not, make the tweaks you need to make and then get to work.
A budget is not set in stone. You may examine it every month and compare your actual results to your budget and see what habits you need to focus on. This may cause you to change your budget.
Many organizations have given up on the traditional budget and have implemented a rolling forecast where once a month has past, the actual results are added for the month and a new forecast or budget month is added to the future so you always have 12-16 months of looking out into the future.
Do you need a budget for your business?
In reality, you may not need a budget. Budgets don’t work for everyone and in some organizations I have worked with, they were a wasteful exercise as they were never used to adjust habits or touched after they were prepared.
You may need a budget if you plan to make changes to your habits and want to measure and track the results of those habit changes.
In the end, a budget, as a tool, is only good if it is used. Budget the results of your habits.
This blog allows you to experience the raw, gut wrenching drama of human conflict through accounting in each of its three stages: preparing to do battle, the thrill of victory and the agony of defeat.