Is Your Budget Ready for Worst Case Scenario?
A well-maintained budget is a crucial tool for any small business—but knowing where your company stands financially in a turbulent economy can be the difference between riding out the downturn and failure.
“In predictable times you had very easy assumptions—you could assume your cost structure wouldn’t change dramatically, for instance,” says Paul DelFino, a partner of small business consulting firm Opportunity Inc. “In this environment, however, small businesses can't afford to take anything for granted.”
So where should you start when creating an annual budget in this economy?
“Do a situation analysis—here’s what I’ve done, here’s where I am, here’s where I’m going," says Ron Beilin, president of Opportunity Inc.. "And ask yourself if it still makes sense.”
You should not only review your overall business strategy, but Michael Scotto, of the non-profit advisory association SCORE, suggests to create “least likely, likely, and most likely” scenarios for your sales forecasts over the next 6 to 8 months to determine how each category will affect gross profit and pre-tax net.
“Then create the methods to track where you’re trending and figure out what’s working and what’s not so you can make adjustments to your plan,” he says. And here are a few more tips on building a better budget.
Examine existing resources and customers. But before making adjustments, Scotto urges small business owners to avoid budgeting in unnecessary costs by going over existing resources such as current customers.
“One of the most expensive marketing elements for small businesses right now is to attract new customers, and that takes a large part of the budget,” he says.
“Take a look at who you have as existing customers, cement those relationships, and see whether or not you can get more sales out of them by offering more services and different kinds of products rather than trying to build a new customer base.”
Build “sub-budgets” and plan for “what if” scenarios. If you are planning a new marketing campaign or product launch, DelFino suggests creating a “sub-budget” first, especially given today’s economy.
“Unfortunately in the new ‘Wild West,’ sometimes your best guesses on what you thought you’d be able to do don’t happen,” he says. “So new initiatives should have separate budgets that you pull into the real budget when and if they launch.”
Even if you green light your prospective plans, DelFino goes on to warn against putting your budget in the red.
“The problem is when you become so married to your idea that you keep throwing money at it and you don’t know when to back off,” he says. “You have to ask yourself, ‘How much am I willing to gamble?’ Set that number and live by it.”
In such a fluctuating economy, experts say it's crucial to factor in variables such as fuel, healthcare, and raw material costs by creating “what if” scenarios, and having enough money set aside to handle when probabilities become realities.
“The idea that anyone in today’s environment can wing it is wrong,” DelFino says. “You’ve got to start building scenarios and you can’t assume anything.”
Start a monthly “pro forma” approach. Once your budget is in place, DelFino advises small business owners to actually take the time to review it thoroughly.
“Most entrepreneurs do the budget, congratulate themselves, put in a drawer, and move on,” he says. “What Ron and I emphasize is forcing the discipline.”
Beilin recommends reviewing your budget monthly using what he refers to as a “pro forma” approach.
“We spread out the budget over 12 months with revenue and every single line item expense, and then each month when we get actual numbers we’ll replace the budget for that month with the actual and then look at that based on the new information we have,” he explains. “If we look at that number and it doesn’t tell us what we want to hear then it’s time to create the change right then.”
Beilin also stresses the fact that the budget is merely the “accountability number.”
“People freak out if you say you’re adjusting the budget every month. I’m not saying to adjust the budget—always measure against that,” he says. “I want to know where I’m going and that allows me to react and make changes every single month. And that’s what’s required today.”
Heed the red flags. When reviewing your budget, beware red flags that could spell disaster for your business if left unresolved. And for Beilin and DelFino, monitoring your margins is of the utmost importance.
“When your margins start creeping, even if your volume is off a smidgen, that’s more than a red flag—that’s a serious problem,” says DelFino.
Aside from missed revenue goals and line items exceeding originally projected costs, Scotto wants small business owners to pay attention to cash flow.
“A lot of businesses that develop profit and loss statements don’t do a cash flow analysis. You really need to start paying attention to what cash you have to work with,” he adds.
The payoffs from a well-maintained budget: An up-to-date budget can be advantageous to a business beyond the obvious benefit of staying on track—you can also use it to anticipate peak periods, or, as Scotto calls them, “violent peaks.”
“A lot of people don’t realize there are peaks in their businesses and ways to make them violent, which means you’re going to bring your sales structure way up off the charts,” he says. “That’s the time of the year the customer is telling you they want your goods and services—that’s the time they have the money, and that’s the time they want to spend.”
Beilin points out that a budget can also be an effective communication tool.
“If everyone is going off and doing their own thing, it’s very difficult for each department to understand how they affect each other,” he says. “A budget forces everyone to be accountable and to be on the same page.”
Bottom line: Go beyond just creating a budget by rote and keep your business ahead of the economy. Says DelFino, “Having the budget does nothing—using it is what counts.”
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