PME: 6 Tips for Establishing Your Provisional Budget
Entrepreneurs, if you have not yet completed your 2017 budget, it’s time! Even if the exercise is somewhat long and tedious, especially if you want to be very realistic, it is the essential tool for steering your business.
Establishing a budget is to imagine the activity of your company over a full year, especially the expenses and the turnover based on your sales objectives.
Why establish a budget estimate?
The budget is a kind of roadmap for the next 12 months. It includes all the inputs (sales forecasts, new financing) and outflows (investments, purchases, overheads) of cash that you expect in the next financial year.
Making a projected budget allows you to set goals for the coming year, monitor your performance and identify any difficulties that may arise before they impact your business in the long term.
This step, essential to the good management of your company, deserves to spend time and demands of the organization. To support you, Small Business Act gives you 6 tips to establish your budget.
Tip # 1 – The 7 Right Questions to Ask
For your budget to be effective and relevant and to support you in making decisions throughout the coming year, there are a number of things to consider:
- What are your sales forecasts?
- What will your variable costs be? (raw materials, cost of delivery, energy consumption)
- What will your fixed costs be? (HR, rents, financing cost)
- How do you plan to change the workforce? (recruitments, end of contracts, bonuses)
- What will be your tax burden?
- What will your financing be?
- What is the evolution of your market and your competitors?
These are the questions that every entrepreneur must answer in the context of the preparation of his budget estimate.
Tip # 2 – Make your forecasts month by month
In order for your budget to serve as a real roadmap, it is not necessary for all the elements to be detailed month by month. This will allow you to monitor regularly and adjust your budget as the year progresses.
The monthly budget will allow you to regularly review your forecasts and compare them to your position. This will also allow you to not be surprised by the effects of calendars (holiday period, end of year that depending on the sector can result in a significant increase or slowdown in activity).
Tip # 3 – Make two different scenarios
Like most entrepreneurs, you are likely to navigate between the following two scenarios:
- One very cautious, even pessimistic, who will allow you to fall back on your feet in case of difficulty;
- The other favorable and bold, which will be a source of inspiration, enthusiasm and positive projections.
By preserving a window open to your dreams and ambitions, you promote your creativity and that of your employees.
For example, scenario 1
- A low selling price
- Communication via 2 types of networks
- No commercial team
- And only a new product put on the market every year for 3 years.
And scenario 2
- A cheap basic product and a more elaborate product marketed at a high price
- A wider communication via 3 to 4 different networks, managed by you and a marketing director
- 2 paid commission sales
- A new product on sale the first year
- Then 5 more in the next 2 years.
It is important that your projections do not just look at the worst, but suggest some success. This allows you to ensure possible phases of development in its various components: inventory, recruitment and outsourcing.
Tip # 4 – Involve your teams
Who better than your sales team can help you predict future sales? or your HR department to forecast the cost of labor? For your budget to be realistic, it is important to involve all your teams. The objectives that you will define there will also be theirs. To do this, ask them their forecasts, confirm the different hypotheses with the teams concerned, in case of conflict between different departments (for example between the commercial and financial teams), ask them to find a compromise on which they will commit themselves.
For them and for you, the estimated budget will accompany them all year in their tasks.
Tip # 5 – Check your projections via a few key-ratios
Tools for measuring and controlling the evolution of your activity, ratios are percentages or coefficients relating values to each other. They provide valuable information to the entrepreneur, for the analysis of solvency, financial balance or the economic profitability of the company.
They do not necessarily have value in themselves, but must be compared either from one year to another for the same company, or compared to those of another company in the same sector and of similar size. Ratios are one of the best ways to reconcile your sales and cost forecasts! Here are some rations that will help you master the consistency of your overall budget:
Gross profit rate
What is the ratio between your turnover and your total costs in a given year? This is one of the ways to see if your budget is realistic.
Pay attention to forecasts that indicate an increase in your gross margin ratio of 10 to 50%.
If your operating costs are high, there is a good chance they will stay in year n + 1.
To be more precise, the calculation of the gross margin rate is as follows (in%) :
(CA – Purchases) / CA x 100
Operating margin rate
What is the ratio between your operating profit and your turnover in a given year?
Here we expect a positive evolution. As your turnover increases, your rate of return should also increase.
The mistake made by many entrepreneurs at this stage is a bad anticipation of their break-even point. They think too prematurely the date on which the company will earn a profit margin. As a result, the necessary funding before reaching this threshold. Calculation of the operating margin rate (in%): EBIT / CA
Total workforce by customer
If you are the entrepreneur-orchestra type that is gearing up to advance your business, I would advise you to take a look at this ratio. Have fun dividing your number of employees (only one, so if you have all the caps) by the total number of customers you plan to meet. Ask yourself if you sincerely believe you can manage such a large portfolio in the next 2 or 3 years, depending on your forecasts. If this seems unrealistic, it would be wise to raise your assumptions in terms of human resources, and therefore operating expenses.
Tip # 6 – Track and update along the way
Finally, once your budget has been established and validated, put in place tools to compare the actual situation with the budget. At the end of each month or quarter, for example, compare each figure with what you estimated. The budget will serve you to analyze the evolution and growth of your business, but also to identify as soon as possible structural and economic problems that could impact your business (rising raw material prices, difficulty in recovery, problem in the forecast, evolution of sales forecasts).
As you go, you can reshape your budget with the new forecasts. For example, if you are hiring or if the promises to sell are stronger than expected, you can establish a new budget based on these new assumptions. At the end of the year, the provisional budget will also be very useful to analyze and understand the mechanisms that have guided your evolution. Well used, the budget is an excellent steering tool and the best ally of the entrepreneur. It helps set clear goals, plan the resources needed to reach them and have good visibility on your business.
This exercise requires rigor and an important investment, but by respecting certain fundamental rules, you increase your capacity of anticipation and you limit your risks. Do not hesitate to ask your accountant to assist you in this task.
He will write for you your budget, according to the forecasts and the hypotheses that you will transmit to him.