Don’t Plan to Fail: Budget Planning Works
The adage, “If you fail to plan, you are planning to fail” has been attributed to Benjamin Franklin … and ignored by business owners from his day on.
Business owners offer plenty of excuses for not planning, particularly when it comes to budget planning. It’s not until failing to plan sabotages their success that entrepreneurs grasp the true meaning of the adage.
A budget is supposed to function simply. It outlines how you will pay for necessities, and expand as required. But when that budget exists only in your mind, you’ve become a virtuoso in the art of self-delusion.
To genuinely assure that your budget is sensible and meets its intended purpose, it must satisfy certain time-tested principles. That entails committing some time at year-end to scrutinizing your written budget.
Start by understanding the leverage points in your operations using accurate recent financial statements. Obtain from these reports the key ratios that form assumptions in your budget.
Specifically examine direct costs for business projects, such as materials and labor utilized for processing billable work. Your gross profit margin is what’s left from revenue after paying direct costs. In general, whatever revenue you predict for next year will generate the same historical gross profit margin percentage. To accomplish a different margin, you’ll have to take some action to contain costs; however, growing revenue while incurring a slower rise of direct costs will deliver an immediate benefit to your bottom-line profit.
Reliable budgeting requires a firm knowledge of general and administrative costs. Understand which expense categories are the largest. Any meaningful budget – particularly an optimistic one that predicts improvement – should reflect changes to big-dollar items. For variable costs, set an expenditure limit that’s a percentage of revenue. Your financial reports convey the historical percentages. Locking in percentages for variable expenses can be useful if and when future revenue either exceeds or falls short of expectations.
Fixed costs are the most troubling expenses. They kill profitability during an economic downturn or period of slower-than-anticipated sales. You have to pay them no matter what, and they’re difficult, if not impossible, to change once you lock them in place. Using previous financial statements, find out which fixed expenses have changed the most as a percentage of revenue. You should consider re-examining any fixed costs that are placing increasingly difficult demands on revenue. Lower rent, cheaper insurance, and reduced usage of utilities are common ways to alter fixed costs.
Without an action plan, a budget is just a bunch of jumbled numbers that you hate to confront. What makes budgeting valuable is that it establishes a strategy for managing your business. The tactical methods necessary to attain projected revenue are merely part of your strategic planning. Only by simultaneously spending as established in your budget can you reach your profit objectives.
Analyzing expense patterns and creating realistically defensible budget allocations is tedious. But it’s better than suffering through a year of unmet intentions by not planning. Franklin would be proud.