It was a tiff between two people in a client’s business that prompted this question. One was the business owner (let’s call him Al), and the business manager (Bill).
Bill had done the right thing, in my view, he’d taken the time to review income and expenditure for the previous month against budget, and comment on the variations. Al didn’t disagree with the figures, but as owner, had a different perspective on the variations. In essence the difference was about how rigidly variations from budget should be treated.
I won’t go into the details, but one of the issues that needed to be resolved was a better understanding of the role of the budget in their business, and how to use it to fill that role.
Let’s go back to tors and look at exactly what a budget is. Your budget should not be a meaningless document that you prepare just to say you have one, although I’ve seen this. Your budget should be the course you have decided upon for your business, an expectation of what you want your business to achieve.
The budget is something that is compared to actual results to determine variances from expected performance, so that you can make informed decisions.
Your financial statements are a picture of the past; your budget maps the road ahead. Mixed metaphors I know, but you get the point. Financial statements are lag indicators. They measure what has happened, where you have been. Your budget is where you want to go.
Budgets usually represent a detailed analysis of how a company expects to spend money in future time periods, and the returns from that expenditure.
It should reflect how you expect your business to perform, financially speaking, if the strategies, events and plans you have prepared are put into action. You do have such strategies and plans, don’t you?
So you need to compare your lag indicators on a regular basis, what has actually happened, with the results you planned to happen. Note the word “regular”; you don’t want the lag to be too great, otherwise you could be well off your planned road to the future.
And that is where “variations from budget” come in. Inevitably, both from a revenue and an expenditure viewpoint there will be positive, and negative, variations.
Detail is important in both Costs and Revenue, not just the bottom line. I’ve always been keen on identifying what a business’s offering contribute in terms of both Sales and Gross Profits, and the market segments which from which they come. I call it a Customer/Sales Matrix.
This is a powerful tool, particularly when measuring Gross Profit. It helps you pinpoint opportunities for improvement both in what you are offering the market, but also those customer groups where action will be most effective.
Not all budget variances indicate a negative business situation. If budget variances occurred due to unexpected growth in sales revenue, you may need to increase the budget amounts for future sales increases. Such increases will also explain increases in expenses, particularly variable costs. They may also reflect the results of increased or improved marketing.
It's why I’m keen on regular reporting so we have information from which you can make informed decisions. I wrote about this in “Can you see the Way Ahead”. If your strategies and plans are not working, then you want to know as soon as possible, not three months after the end of the financial year. You want to know early enough to take action to get you back on the right path.
Which leads me to another important question: “Why is it so?” When you have variations from budget it is important to understand why such variations occurred. Having detailed information, not just a broad-brush comparison helps here.
But it also means reviewing those strategies, events and plans, how they were executed, market conditions, and a whole range of internal and external factors.
Beware the “Three Blind Mice” Syndrome – “Don’t worry, be happy”, ignore the problem and hope it will solve itself. It’s so easy to fall into the trap of using external factors as a convenient excuse for not taking action.
Another powerful tool to use is TRENDS. One month’s variation may be an anomaly, but three months can show a serious trend. It may be positive, it may be negative, but trends give you a very clear message.
Finally, the real secret to any business budget is its (and your) ability to be flexible. If revenue falls below target, you need to know what changes can be made to the budget to help bring it back on track quickly. While an initially well-structured budget is the key to achieving your financial goals for the year, the reality is that they require constant tinkering at regular intervals, as revenue and expenses fluctuate.
Shakespeare expressed it well, although I’m not sure he knew much about budgeting:
“There is a tide in the affairs of men,
Which taken at the flood, leads on to fortune.
Omitted, all the voyage of their life is bound in shallows and in miseries.
On such a full sea are we now afloat.
And we must take the current when it serves, or lose our ventures.”
If a strategy or plan is working well, producing sales and profits, then you will probably want to take advantage of this, and build on it. If not, it just becomes another missed opportunity.
Budgets are not set in stone. They need to be reviewed and adjusted where necessary to reflect changes in conditions, strategies and plans. Having the flexibility, through spare cash and an ability to cut or increase spending as needed, along with a determination to stick to your budget, are the best moves you can make to ensure your business reaches its profit goals, continues to grow even during changing economic conditions, and most importantly remains viable well beyond the current financial year.
And that is just what Al and Bill are doing, being flexible, but recognising that they need to be guided by their budget if they are going to take the business to where they want it to be.
When clients approach me for coaching, clients with businesses that are underperforming despite the crippling hours and effort the owner is putting into them, it is not just marketing that is holding them back. It is the lack of control they have over their business, and eight times out of ten that lack of control comes down to a lack of knowledge of what is happening in the business.
Very often that is because they have not adopted a rigorous budgeting process. They don’t treat their budget seriously, nor review it regularly. And if they do, variations are not thought through.
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© Copyright 2016 Adam Gordon, The Profits Leak Detective
Some profit losses are pretty obvious - so you fix them.
BUT, what if you don't know profits are leaking, cash out the door?
Possible leaks could be anywhere.
Are there some clues or symptoms that are tell-tales?