Budgeting tips for SMEs
When first starting out many SMEs underestimate the importance of having a budget in place when, in fact, a budget plays a pivotal role in the overall financial wellbeing of a business. SMEs are often more in need of a budget than their larger competitors because they have fewer financial resources. A budget is a valuable tool SMEs can use to keep their finances in check.
All businesses experience fluctuations in their finances, regardless of their size. Having a budget in place allows a company to plan for any future financial hurdles such as seasonal dry spells, unanticipated expenses and slow payments from customers. A budget, therefore, gives a business the chance to contribute funds to a 'financial safety net'.
Ultimately, the goal of a budget is to ensure that a business has enough funds available to sustain its growth, efficiently manage cash inflows, outflows and not suffer financial ruin as a result of unplanned expenses.
Below are some tips on how to use a budget to effectively manage the finances of your business:
Define and understand your business risks
Every company operates differently which means there is no one size fits all approach when it comes to creating a budget for your business’s specific set of risks. However, one way you can make sure you have all your bases covered is by looking at your business’s risk areas and creating a risk management plan, which details your strategy for dealing with each specific risk.
Analyse your business’s critical activities, assets and liabilities, cashflow, credit terms, payment terms and any possible physical liabilities within the working environment of your business.
Once you have a clear picture of your overall business vulnerabilities in mind, think about what your business couldn't do without, and what factors may have an impact these weak areas. Create a financial contingency plan (whether this is insurance or an emergency fund) to safeguard your business and limit the financial implications of these risks.
For example, a manufacturing company should analyse the implications and costs associated with the loss of a vital piece of production equipment and any costs associated with its downtime. To counter this risk, the manufacturing company could budget for machinery insurance and optionally loss of income cover to safeguard itself against physical or financial losses in the case of significant assets breaking down.
Create a budget
Once you have an overall holistic view of the strengths and weaknesses of your business, you can create an effective budget to help drive your business forward. The budget will give you more control over where, and how, capital is spent, allowing you to make more informed business decisions and better navigate your business path to success.
The simplest way to create a budget for your business, is to use previous financial statements to benchmark and set future financial projections. However, if your business is newly established, you will not have any historical information available. So, it is essential that you include the information below in your budget and update the amounts monthly, quarterly or, at the very least, annually depending on your business structure.
- Revenue (all income)
- Cash inflows and outflows
If you are just starting out, you will have a rough idea of the business's cost of sales, fixed costs and expected output needed to breakeven or make a profit (this would be detailed in your business plan). You will need this information to create your budget.
All money that moves in and out of the business needs to be recorded in your budget. If you have just established your business this includes all startup costs. The incoming and outgoing money must be compared to the projected or estimated amounts, going forward. This will tell you how the company is performing compared to your targets, and depending on the results, the business’s direction can be adjusted, or redirected, accordingly.
It's essential to make sure that all your anticipated income has a purpose. Uncategorized funds are often spent with the least foresight.
Use your business budget to grow your business
Your business budget is your business’s roadmap to success. It should be simple, straightforward and should contain realistic and attainable targets. If you use your business plan as a base from which to create a budget, you will be creating a financial action plan .
Your 'financial action plan' will help your business grow by:
- Informing big business decisions
- Provide insights into how to allocate resources adequately,
- Support proactive financial management
- Troubleshoot potential problems before they happen.
Overall a budget is a handy tool to help a company better understand the interconnectedness of its different departments and ultimately leads management to be better prepared to address the inevitable financial variances from the forecasted budget by providing a structure from which to assess the variances.
A budget should be a working document
While many large firms draft a budget each year, SME owners should do so more regularly. However, often small business owners only plan a month or two ahead as a new business can be volatile and may have unexpected expenses which can drastically impact revenue and cashflow.
A budget should be a working document that is supported by a dynamic cash management system which should include a Profit and Loss document, balance sheet and cash flow information for each month. This information enables management to quickly analyse how the business is doing, which gives the company sufficient headroom to navigate any projected cashflow issues.
Being proactive allows a business to spot small issues early on and prevents them from growing into significant problems.
Benefits of having a business budget
There are many benefits of using a budget for SMEs. However, it's essential to remember that while a budget is certainly a helpful tool, it is not a forecast. A budget is a planned outcome which is defined by what a business hopes to achieve.
A budget allows a business to:
- Manage its finances more effectively
- Make informed decision to better allocate resources
- Monitor its performance and ROI
- Meet its goals and objectives faster
- Manage possible future financial issues, such as cashflow problems
Overall, a budget gives a business a foundation from which to base its financial decisions and plan for the future.
A budget can reduce financial risks through cashflow monitoring
Having a budget allows a business to lessen the impact of cashflow issues resulting from clients requiring longer credit terms. However, what if a company does not have enough of a safety net set up to cover business expenses in the interim?
Despite the costs – and risks – associated with taking on regular debt, many SMEs don’t always have another option. Merchant Factors offers an attractive alternative financing solution called factoring.
Factoring involves the business selling the cash flow it expects to receive from clients (accounts receivable) to a third-party organisation (Merchant Factors), for cash received upfront. In this way the cashflow struggles of the business is alleviated and the cost of potential debt is avoided. With additional working capital, the business owner can also invest in risk reduction upgrades for the company and maximise its tax deductibles and in so doing, optimise its financial expenditure.For fast, flexible business finance – contact Merchant Factors today.
Finance beyond the Numbers.