JOHANNESBURG - It is important for an entrepreneur planning to enter the market to keep a tight hand on business budgets and cash flow.
After all, a business without a working budget is like a car without a fuel gauge - it will drive for a while, but will run out of fuel when the driver least expects it.
While the specifics of a budget are dependent on the nature of the business, all small-business owners should consider the following essential tips for effective budgeting which are universal for all businesses.
Cover the basics
A budget should include at least a sales forecast, a cash-flow forecast, an income and expenditure forecast and a capital expenditure forecast. Of these, the most important is the cash-flow forecast as it provides fair warning if a business is at a high risk of running out of cash. It is important that cash-flow forecasts take into account the cash lag from the date of paying suppliers to receipt of payments from customers.
A budget is an estimate of the business's income. The more accurate the revenue estimate is, the more useful the budget. However, entrepreneurs are often eternal optimists who sometimes overestimate income. This can be just as harmful as it gives a false sense of security that expenses will be covered. One of the best ways to project realistic income is to base figures on historical sales data and ensure that deviations are based on realistic factors. In the absence of historical sales data, due diligence into similar businesses should be done and realistic yet challenging sales forecasts should be set.
Understand the macroenvironment in which your business operates
In today’s global economy, what happens in China or the US will have an influence on your business. In South Africa, a basic budget line item like fuel is linked to macrofactors like the world oil price and the strength of the rand. Businesses that rely on imported materials, for example, need to have plans in place to absorb exchange-rate fluctuations, when to pass it on to clients and even when to start sourcing locally rather than importing. As such, a good budget is plugged into the macroenvironment.
Do it yourself and revise it regularly
While accountants are useful in tax and financial statements, business owners have the best knowledge of expected levels of sales in coming months, as well as the expenses to be incurred in order to meet those sales.
It is therefore advisable to draw up your own budget and approach accountants only to assist. The value of a budget comes to the fore when an entrepreneur reviews, consults, adapts and compares the forecast figures with the actual figures, at least once a month, in order to identify material variances. If not, sales dip and rising expenses will be noticed when it is too late.
Budget for extra cash
Budgeting is not only to prevent death by cash-flow crunch, but also to help entrepreneurs plan for what to do with extra capital. Sensible budgets include plans to invest extra cash into accessible short-term money market accounts, for example, or into long-term investments, such as buying a building if the entrepreneur is sure that income and profitability can be sustained.
Understand the difference between fixed and variable costs
Fixed costs are those that stay the same no matter how many sales are made in a month. These include rent, salaries and loan repayments. Variables, as the name implies, vary as the level of sales vary. These include raw materials and commissions. Failure to understand the difference means that a business owner is not able to use crucial business management tools such as gross profit ratios and break-even analysis.
Be ready with Plan B
New businesses should have two budgets - one for when things go well and another for when things turn bad, which should include a break-even scenario and reflect the minimum sales required to meet overheads and keep the business going. Sensible business owners should have a plan for when their budget suffer a major knock such as the loss of a major client or aggressive competition. Entrepreneurs have the temperament to live with such risks, but it is best to mitigate them by planning for all possible scenarios, always keeping the budgets close at hand.
At the best of times, budgeting is one of the most important habits that separates thriving business owners from the mass of struggling businesses. When times are tough, the ability to budget effectively becomes a matter of survival.
Ben Bierman is a managing director at Business Partners Limited