The Virtual CFO

Revising Your Budget

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.

Video Blog: Adopting a Lean Business Model for a Start-Up

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.

How to Use Your Budget as a Tool

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.

Using Your Budget as a Tool – Two Methods for Accomplishing This

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.

Happy Third Birthday, Virtual CFO Blog

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.

Using Your Budget as a Tool - Overview

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.

Cash Flow Budget - Part 2: The Dynamic Cash Flow Budget

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.

Cash Flow Budget - Part 1

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.

Non-Production and Tax Budget, Part 2

This brings us to the most important element of the non-production budget, which is estimating your company’s tax liability (or your personal tax liability if you own a pass-through entity such as an LLC or S-Corp).

When you subtract the production budget, the general and administrative budget, the capital expenditures budget, and the non-production budget from the sales revenue budget, you have the net income for your company. The taxes you will pay for your business are calculated from this figure. This is true for C-Corps, who pay corporate taxes, as well as LLC’s and S-Corps, whose owners bear the responsibility for paying the taxes on net income.

I use a flat percentage to estimate the tax burden when I construct a tax budget. If your company has been in business for a few years, you can use the last year or two as a reference for this percentage. If your company is a new start up, I recommend researching the tax percentage due on your estimated net income by consulting with your CPA or looking at the IRS website.

Non-Production and Tax Budget, Part 1

In an earlier post (Budgeting for Small Business, Introduction #2), I called this the “Interest and Tax Budget”. The more appropriate name for this budget is the “Non-Production and Tax Budget”. This budget includes any revenue and expense that is not directly tied to the operations of your company as well as an estimate of the taxes your company will pay during the budget period.

Non-production revenues and expenses include legal judgments that you expect to win or lose, interest income or loss from investments, etc. Small businesses usually have very few non-production revenues and expenses, so they are fairly easy to identify. However, these items affect the net income that is used to calculate your tax obligation.