How-To-Guide: Business Budgeting During Inflation
As we roll into December, business owners are focused on ending 2022 strong and preparing for an even greater 2023. Included in the year-end planning objectives is the desire to hit growth targets, improve the availability of capital resources, and control expenses for the coming year.
Naturally in a high-inflation environment, budgets are being examined based on potential concerns for higher spending on the supply chain, payroll, and benefits, meaning there’s less money to go around for other critical projects and investments. Budgeting and planning season is a daunting task. Many clients come to me with the same concerns: where do I start and how do I stick to a budget – especially with future inflation, a potential recession, and continued supply chain disruption?
Budgeting from Every Angle
What’s the best approach for your business? Top-down or bottom-up budgeting?
Depending on the size of your organization and if you have various departments heads, each of these different approaches to budgeting may work best.
Top-down budgeting refers to a type of budget allocation where executive leadership and senior management set high-level budgets based on company goals for the year. Once approved, management “pushes down” the budget to the management teams, who communicate and monitor the budgets with their teams.
Bottom-up budgeting is the opposite of top-down budgeting, the CEO or Business Owner drafts plans based on their strategic needs and goals, then present it up to their managers. Each department needs to identify their goals — and what it costs to achieve their goals.
Once you’ve identified the best approach to map out anticipated spending for the coming year, following these steps will ensure you stick to a budget and avoid surprises:
- Frequently monitor the numbers.
You can’t know your numbers – and you need to know your numbers! Since we are living in an inflationary environment, it’s important to keep a close eye on the critical numbers that can help monitor climbing expenses and how that is having a negative ripple effect on other critical numbers that include:
These key numbers include:
Cash Flow
Profit and Loss
Sales
Price/Selling Point(s)
Gross Margin including by product line and by customer
Net income
Total Inventory
Stay on top of your numbers.
2. Calculate Your Return on Investment
Business owners can use return on investment as a measuring stick for their company’s profitability. The amount of money spent vs. the expected financial return should be a focus of performance management. The data collected from your ROI tracks what efforts you are investing company funds in are performing best.
If you determine you are wasting money on an expense, rethink your strategy as something needs to change. Many types of ROI can help you make important businesses budgeting decisions such as: purchasing new equipment, hiring new employees, investing in marketing, or expanding into a new geographic location. Practically every business decision requires knowledge of ROI. Simply divide the gains from your investment by your investment’s cost and you have your answer as a percentage or ratio.
3. Track Your Sales Cycle:
There are a number of factors to consider:
How long does it take to move prospects through your sales pipeline? The answer depends on how many steps are in your sales cycle, how complex your product is, and the cost of your offering.
What are the projected sales for the budget period? If you overestimate, it will cause you problems in the future.
What are the direct costs of sales (i.e. costs of materials, components or subcontractors to make the product/provide the service)?
What are the fixed costs?
What are the overhead costs?
The length of time it takes to convert leads to sales needs to be factored into your budget. Using your sales and expenditure forecasts, you can prepare projected profits for the next 12 months and beyond. This will enable you to analyze your margins and other key ratios such as your return on investment.
4. Overestimate expenses.
By overestimating monthly expenses, businesses can account for the possibility of variable unexpected expenses. A suggestion: take your total expenses, then add at least 5% to cover the unexpected financial surprise. Most businesses can categorize their expenses in three areas (see below). By analyzing spending history, you can estimate your monthly expenses in each category.
- Fixed expected expenses: Expenses that come at regular intervals (weekly, monthly, annually, etc.) and don’t vary are called “fixed.” Examples can include building rent, insurance premiums, equipment leases and payroll.
- Variable expected expenses: Expenses that come at regular intervals but can vary are called “variable.” Examples can include utilities, phone bills, employee training, bonuses, donations.
- Variable unexpected expenses: Otherwise known as “emergency expenses,” this category is the most likely to trip up even the best budget plans. For example, no one plans for a major piece of equipment to fail or their biggest client to jump ship.
5. Improve Cash Reserves and “Emergency Funds”.
In business, rainy day funds or retained earnings are cash supplies that are kept on hand to enable your business to continue operating in lean times or in an emergency. Many businesses during the pandemic did not have more than three months cash reserves and failed to stay afloat.
These funds allow your business to keep providing services while making payroll, paying bills, and purchasing supplies, and they allow the Owner to sustain the family’s income. The emergency fund provides immediate access to funds during critical times. Insurance may cover loss, property damage and other repairs, but processing claims can take weeks or months, putting a sledgehammer through your profitability and productivity. Budgeting for the emergency fund while keep you in business if a crisis should strike.
6. Avoid Deviating from the Budget.
By making and following a budget, you can better control costs, avoid overspending, and plan to meet financial goals.
It is important that you compare actual results vs. the budget and investigate any significant differences and the causes. Failure to properly use your budget can seriously impact your bottom line, and even jeopardize the success of your business. Tracking your expenses is one of the key factors in making your budget work for you. Over time your budget will allow you to track revenue, expenses, and cash flow. A budget provides a guide to cut unnecessary spending, allocate revenue to other areas of the business, prepare for busy seasons and slowdowns, plan for required purchases, and secure funding from financial institutions.
7. Plan Ahead and Constantly Scrutinize.
Budgeting takes time and usually requires a few iterations. Depending on the size of your business and your goals, budgeting can take anywhere from a few days to several weeks. While creating a static budget can act as a guideline and serve as a basis for your budget vs. actual comparison, a dynamic budget adjusts to the changes in our economy, especially with high inflation, supply chain challenges, and labor costs, serving as a good ongoing forecasting tool. Budgets should be updated regularly and monitored throughout the year to adapt to the changing needs of the business.
8. Seek professional advice and guidance.
Building a realistic budget is an effective way to help keep your business profitable. It might be difficult at first by being realistic and strategic about your budget and tracking the actual results against the budget will help your business stay healthy and successful in the long run.
Even with all the right tools in hand, there are still best practices to keep in mind when producing your budget. Follow these tips to ensure your team is well-informed and better equipped to achieve company goals. Professional guidance can help you set and keep clear objectives. A CFO and business advisor can help you set your budget around your company goals. An outside perspective can help you see overlooked possible expenses you will need to allocate to achieve your projected budget. If you need help building your company’s budget or want to ensure you’ve built a budget that fits your goals and your unique situation, contact AETucker Consulting for help.
As a fractional CFO, I help owners, management and board members solve financial and operational challenges by providing unique and customized guidance.
To learn more about how I can help your business create a solid budget or implement strategies to improve your financial wellness, please contact me via email at Andrew@aetuckerconsulting.com and check out my website www.aetuckerconsulting.com.