Building an effective budget for your SME
A well crafted and realistic budget is a vital tool for any small and medium sized enterprise. With tighter margins, and typically less scope for exponential growth, these companies must take a forensic view over their incoming and outgoings, or risk the worst.
Research by CBInisghts found that 38% of UK SMEs fail because of poor cash flow management. While no recent data exists for the British market, a look at the US gives a sobering picture of how detailed small businesses are in this regard. According to the B2B services marketplace Clutch, just over half (54%) of businesses have a properly detailed annual budget.
In this article, we’ll look at the steps your business should take in creating an efficient and thorough budget. In summary these steps are:
- Analyze your current costs
- Negotiate reductions in costs with existing suppliers
- Estimate revenue
- Determine gross profit margin
- Project cash flow
- Analyze seasonal and industry trends
- Set spending goals
- Implement accounting software
Analyze your current costs
Taking a forensic view of the current costs of the business is a crucial step. There are many different outgoings a business may have, from staff salaries, software, office costs and energy bills. Obviously some of these costs are essential, and harder to reduce, but businesses often unnecessarily leak cash by not regularly checking on the money leaving their accounts.
Let’s take energy costs as an example. With prices increasing rapidly, you can take a number of steps to reduce outgoings. Shop around for better deals, audit your energy expenditure and see where you can cut back. For more tips on how to bring spending down, check out our blog on the five steps you can take to offset the energy crisis.
Negotiate reductions in costs with existing suppliers
This initial process will inevitably lead to you looking at the prices involved in your supply chain. Whether your business acquires goods and products, or services, this will likely be one of your biggest costs.
As such, it is a good idea to explore whether you can negotiate, or explore other methods to bring down unit prices. Buying in greater bulk, or agreeing longer contracts might present greater upfront costs, but can also lead to a reduction in total expenditure in the long run.
A crucial step in your original business plan, estimating revenue must continue as your business begins to operate. While these numbers may start out based on projections, keeping track of the money generated by the business will give you an idea of how much will come in further down the line.
It’s a good idea to look at this number over a variety of different time frames. What is the estimated revenue for the next month, and how does that project forward for the coming quarter, and the year ahead?
Determine gross profit margin
Once you have an understanding of expected revenue and your current expenditure, you can calculate gross profit margin. Simply put, this number is the value left when you subtract expenses from incoming cash.
This number can be negative for a while. It’s a given that most early-stage businesses make losses for some time. But leaving this figure in the red for too long leaves you with an ever-decreasing runway, and could mean the business has to borrow to right the ship.
Project cash flow
Cash flow is the net amount of cash coming in and out of the business, as you receive payments for your services or goods, and pay your supplier for the work they have carried out for your company.
The reality of business is that you may have to wait to be paid. This is particularly true of certain industries, where payment terms can run up to 180 days. It’s wise to make contingencies for late payments, as otherwise, your business could be expected to pay outstanding costs while money owed to you hasn’t hit your account.
Analyze seasonal and industry trends
Keeping tabs on cash flow is of particular importance in industries that experience high periods of demand. Tourism, retail, sports and leisure all experience boom periods at different points in the calendar for a number of reasons. During these times revenue will increase, and expenditure will have to match as well, especially if more resources are required.
Furthermore, sudden macroeconomic changes can have a profound effect on projections depending on your industry. Take the Covid-19 pandemic as an example. This had a serious impact on retail businesses, as shops had to close, and many businesses had to scramble to improve their ecommerce solutions. Effective scenario planning means your business can stay on top of sudden shocks and negative trends.
Set spending goals
Even with an idea of current costs, the business will need to make provisions for unforeseen circumstances that require spending. Building in a buffer to the budget by setting spending goals will keep costs down, and eliminate frivolous purchases on company accounts.
Implement accounting software
All of these steps become much easier within the framework of an accounting system. Most software allows you to integrate banking, and will keep a detailed record of invoices, accounts receivable and payable, as well as other costs. At Pennyhills we recommend Xero, as it’s easy to use, and can be adjusted to suit your businesses key performance indicators.
For further advice on how to build a thorough and detailed budget for your business, contact the team at Pennyhills today.