I hope you and your family is having a great and safe Fourth of July weekend.
This morning, Adam Savage of Mythbusters Twittered that he reads the Declaration of Independence and the Bill of Rights every 4th of July.
Sounds like a good thing to do on our country's birthday.
Over the last couple of weeks, I’ve discussed the importance of budgeting for small businesses. I have also walked you through the process of creating a budget for your company. Now I want to take a step back and throw some common sense into the mix.
Don’t let the process of forming and monitoring your budget consume more of your time than is absolutely necessary. Planning is essential to success. However, it is easy to get caught up in the budget creation and monitoring process, and be constantly analyzing your firm’s progress and tweaking the budget to get it more in line with reality.
When you’re doing this, you aren’t selling and producing, which are the most important jobs you perform as a small business owner.
If the budget creation and monitoring process requires a great deal of time, you need to consider outsourcing the function to a CPA (CPA for Small Business, LLC offers this service) or delegating the task to someone else in your company.
When you start using your budget as a tool, you may find that your revenue and expense estimates are not falling in line with the actual performance of your company. When this occurs, you have two choices.
The first choice is to not revise the budget you created for the period and continually analyze the differences to determine how you can become more proficient at making estimates for the next budget. This is a good choice if the differences are not that large.
If the variances are large, I recommend that you revise your budget to be more in line with the actual performance of your company. It really doesn’t do you any good to anticipate a certain level of performance for your firm if there is no way your business is going to attain it. It is better to get your expectations (i.e., budget) in line with the actual performance your company will experience for the balance of the budget period. This can also be a good learning experience that will allow you to gain a better understanding of the revenues, expenses, and cash flows of your business.
CPA for Small Business, LLC is my second entrepreneur venture. My first was a logistics firm I owned for four years in the mid-1990’s.
My logistics company failed largely because I adopted an aggressive-growth, all-in business model, which left me with no cash reserves when the bottom dropped out of the markets we served in the company’s third year.
In this video blog post, I discuss how I learned the hard way that it is best to adopt a lean business model for a start-up company.
Once you have your budget tracking system set up in your accounting system or spreadsheet, you need to begin using your budget as a tool to run your business.
I recommend that you review your actual versus budget reports at least once a month. A good time to do this is the 15th of the month. By waiting until the 15th, you’ll know that most of your vendors’ bills and invoices to your customers have been entered into you accounting system for the prior month. It also gives you time to reconcile your bank and credit card statements.
The first thing I recommend you do when you first review your budget versus actual report is to look at the variances for the totals of the major areas of the report, such as total sales revenue, cost of goods sold, gross revenue, general and administrative expenses, and net revenue. This gives you a good overview of the general budget areas of your business that are performing within expectations and those that are not.
Next, you should drill down and look closely at the line items that are performing above expectations and those that are below expectations. While doing this, you need to determine why these positive and negative variances are occurring. You also need to decide whether the variances are a one-time phenomenon or trends that need to be addressed by you and your firm.
There are two primary methods for using your company’s budget as a tool. The first is to load your budget numbers directly into your accounting system. The second is to use a spreadsheet to track your firms’ budget versus actual performance.
Most of the popular small business accounting software packages allow you to enter your budget directly into the software. These programs have built-in budget variance reports that allow you to see how your firm’s actual performance is when compared to the budget you prepared.
Spreadsheets are a popular means of externally tracking your budget variances. This is my preference for budget variance reporting, because it allows you a level of flexibility and customization that is not possible with small business accounting software packages built-in budget reports. The only downside to this method is that you have to import the actual performance data into the spreadsheet (either manually or through macros). For me, this downside is outweighed by the flexibility you have when you use a spreadsheet for budget tracking.
The Virtual CFO Blog turns three years old. It seems like yesterday that I posted my first blog entry, Welcome, on the blog.
To celebrate the occasion I am posting my first video blog, where I thank you for reading and responding to the Virtual CFO Blog.
I hope you enjoy it.
Over the last few posts, I’ve explained the basics of small business budgeting. Once you have prepared and are comfortable with your firm’s budget, it’s time to turn it into a performance monitoring tool.
When your budget is compared to the actual performance of your company, you will be able to recognize when your company is performing better than expected. This practice also enables you to take corrective action when your firm’s performance is poorer than anticipated.
When you are satisfied with the budget you’ve created, the next step is to integrate the budgets with your company’s actual financial performance so you can monitor the progress of your firm on a regular basis.
Over the next few posts, I’ll dig a little deeper into how to use your budget as a tool.
Next, you use
the production budget, the general and administrative budget, the capital
expenditures budget, the non-production budget, and the taxes budget to
estimate the expenses you will actually be paying (cash outflows) during each
month.
When you pull
all of this together, you have what I call a “dynamic cash flow budget”. I am a
big believer in actively using an Excel based dynamic cash flow budget. Every
time I started a new CFO job, one of the first things I did was create a
dynamic cash flow budget to help me learn the cash flow for the new company I
was working for.
With a
dynamic cash flow budget, you update estimated values with actual cash
collections and expenses paid. This allows you to obtain a good understanding
of the cash flow performance of your business. You also look at the estimated future
cash in- and out-flows to see if there are any adjustments that need to be made
for future periods.
What I like
about working with a dynamic cash flow budget is that it helps you become an expert
at your firm’s cash flow. When you use this report on a regular basis, you gain
a good understanding of how your customers are paying as well as the
obligations your company routinely pays.
If your net
cash flow (cash inflows less cash outflows) is positive, you have a positive
cash flow (remember - Happiness is a Positive Cash Flow). If your net cash flow
is negative, you may need to review your budget and make any necessary
adjustments to bring the cash flow to a positive state.
Cash flow is
king to small businesses. This is why it is so important to budget your cash
flow and to proactively evaluate your expenditures to ensure that your cash
flow will be positive.
The cash flow budget is where you estimate the cash you expect to actually receive and the expenses you expect to pay on a monthly basis. Along with being a benchmark for actual performance, the cash flow budget is also an extremely useful cash management tool. I believe that the cash flow budget is the most important and useful budget a small business can use.
The first step in a cash flow budget is estimating the cash you will actually receive from sales (cash inflows) during the year. Multiplying the expected gross sales (from the sales revenue budget) by a discounting percentage (i.e., discounting the expected gross sales by the percentage of sales that will actually be converted into cash during the year) gives you a cash inflow number. If your company has been open for a few years, you can use historical data for the discount percentage. If not, you can use industry averages or make an educated guess.
You then need to convert the annual cash inflows into monthly inflows. If your sales are relatively stable during the year, you can divide the gross estimated cash inflows by twelve months. If your sales are seasonal, you will need to prorate the estimated cash inflows in a manner that is representative of the seasonality of your sales.
