Any business which has spent more than it earns knows the true meaning of these words by Wilkins Micawber from Charles Dickens’s classic David Copperfield:
"Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery."
To avoid the ‘misery’ of a poorly calculated budget, and to strive for fiscal ‘happiness’, you must keep a few principles in mind.
But before we get into details, my experience of budgeting is that it is both an art and a science; it is difficult to reliably create the perfect, iron-clad budget. There is therefore plenty of room for getting it wrong. Experience, common sense and expert advice all play a part, and the finished budget can never be 100% correct.
Here are a few common pitfalls which trip businesses up:
1. Not determining a break-even point: This can be harder to pin down than it sounds, but operating without a realistic break-even point is like going sailing without checking the weather first. Your business viability hinges on it.
2. Forgetting to budget for both profit and cashflow: Business commonly budgets for earnings and profits, but may neglect scheduling anticipated cashflow. If your business finds itself in a situation where it has to invest more in stock or people, or that its debtors are increasing, then cashflow can become a major headache. In fact, cashflow is so crucial it demands its own budget, especially for those businesses that are seasonal.
3. Lack of flexibility: Any budget needs some ‘wriggle-room’ to allow for unforeseen costs or events that may affect your business. While fixed costs such as rent, vehicle leases or equipment hire can be predictable, other costs will demand some leeway. Each business will be subject to different fluctuating factors, but areas which may trip you up include:
- Exchange rates, which can move quickly and catch import/exporters out
- Fuel, which is always tricky to budget for
- Hiring costs, as you can never quite predict staff turnover any given year – even when things are going well
4. Making time for regular reviews: A budget is a moveable feast and you need to keep tabs on it over the year. Accounting software systems make it easy to monitor performance because once information is in the system it can be measured. But you still need to make the time to review and possibly respond to a potential change in situation.
5. Overlooking the hidden costs of cutting: Cost-cutting is an ongoing necessity for most businesses but what looks ripe for cutting on paper may turn out to be an Achilles heel; for example, outsourcing business functions can end up being more costly than anticipated in terms of quality control, unforeseen costs and a host of other reasons. Staff morale may also be affected by any cuts which seem overly mean or miserly, so always place cost-cutting plans under real scrutiny.
Geoff Steer is a founding partner of Matthews Steer Chartered Accountants.