Does Your Business Have a Budget - Or Just a Spreadsheet Nobody Looks At?

Written by: Melissa Cunliffe (CA)

You prepared a budget at the start of the financial year. But has it actually changed a single decision you've made since?

For many Australian small and family businesses, the answer is probably no.

The budget gets prepared. Sales are estimated. Wages go in. Last year's expenses are increased by a few percent. Everyone agrees the numbers look reasonable. And then the spreadsheet disappears into a folder until someone asks for it six months later.

That isn't really budgeting. It's an annual accounting exercise.

A useful business budget should help answer questions like:

• Can we afford another employee?

• Do our prices need to increase?

• How much cash will we need over the next six months?

• Can we afford the new equipment?

• Why are sales ahead of budget but profit behind?

• What happens if sales fall 10%?

• Are we actually on track to achieve what we wanted from the business this year?

At 3P's Future Accounting, we believe a good budget should be one of the most useful decision-making tools inside a business. If yours isn't, there are three things we would fix first.

A useful business budget helps you make better decisions, forecast cash flow and plan for what comes next.

Fix 1: Stop Building the Budget by Simply Adding 5% to Last Year

This is probably the most common budgeting shortcut.

Last year sales were $4 million. So, this year, $4.2 million sounds reasonable. Wages were $1.1 million. Add a few percent. Insurance increased. Electricity increased. Rent increased. Done.

But that approach assumes the business this year will operate almost exactly like the business last year. Often, it won't.

A meaningful budget should be built from the drivers of the business, not simply last year's Profit & Loss statement.

Start with what actually creates the revenue

• For a trade or construction business: number of employees x productive hours x hourly recovery rate.

• For a retailer: customer transactions x average sale.

• For a professional firm: billable employees x productive hours x average fee recovery.

• For agriculture: production volume x expected commodity price.

• For hospitality: customer numbers x average spend.

This approach immediately makes the budget more useful. Instead of saying, 'We need $5 million of sales,' you can explain how the business actually gets to $5 million. That gives management something it can influence.

Then challenge the assumptions

• Are customer numbers realistic?

• Can the existing team deliver the work?

• Will prices need to change?

• Are wage assumptions realistic?

• Has supplier pricing moved?

• What happens to gross margin?

• Is additional equipment required?

• Will the business need additional working capital?

This is where budgeting becomes planning.

Fix 2: Stop Confusing Profit With Cash

One of the biggest weaknesses in many business budgets is that they stop at the Profit & Loss Statement.

The budget says: Profit $400,000. Great. But then the owner asks, 'Why isn't there $400,000 in the bank?'

Because profit and cash are not the same thing.

A business can make a strong accounting profit while cash is being absorbed by debtors, stock, equipment purchases, loan principal repayments, GST, PAYG, income tax, superannuation, owner drawings, dividends and other balance-sheet movements.

Every useful business budget needs a cash-flow forecast beside it.

The budget asks: Will the business be profitable?

The cash-flow forecast asks: Will the money actually be there when we need it?

Example: the budget forecasts Revenue of $3,000,000 and Net Profit of $300,000. But the business also plans to purchase $200,000 of equipment, repay $120,000 of loan principal, increase debtors by $80,000 as sales grow, and pay $100,000 of prior-year tax.

The business may therefore generate a $300,000 accounting profit while cash actually decreases. Nothing is necessarily wrong. Without a cash-flow forecast, however, management may think something has gone terribly wrong when the result was completely predictable.

Your tax obligations need to be inside the forecast

• GST

• PAYG withholding

• PAYG instalments

• Superannuation

• Income tax

These are not unexpected expenses. They arise because the business is operating. A business should not discover its tax position when the BAS arrives. The forecast should already have anticipated it.

Fix 3: Stop Treating the Budget as Fixed

Perhaps the biggest problem of all is the idea that the budget is prepared once and then protected like a historical document.

The budget is the plan. But businesses change. Customers change. Interest rates change. Wages change. Supplier costs change. People resign. Major customers arrive. Major customers leave. Equipment breaks. Opportunities appear.

That is why the budget and forecast have different jobs.

Keep the original budget

Don't rewrite history. If we budgeted $5 million of sales, keep that original target. But every month compare:

• Budget

• Actual

• Latest forecast

  
  

Those three columns tell an incredibly useful story.

Suppose the annual budget says sales of $5 million. Three months into the year, actual sales are $1.1 million against a budget of $1.25 million. Based on the current pipeline, management now forecasts $4.8 million for the year. Now the business can ask what needs to change - more sales, less expenditure, delayed capital investment, staffing changes, better pricing, or perhaps acceptance that $4.8 million is fine because margin is stronger than expected.

Variance Isn't Failure - It's Information

Some business owners dislike budgets because they feel like a scorecard: 'We missed the budget.' But a variance isn't automatically bad. It is information.

Suppose wages are $100,000 above budget. That sounds terrible. But what if sales are $500,000 ahead? Or imagine marketing expenditure is $40,000 above budget, but that campaign generated $300,000 of high-margin new work.

1. What happened?

2. Why did it happen?

3. What are we doing about it?

That's management reporting.

Build the Budget Around Margin - Not Just Revenue

Revenue is often where budgeting begins. But gross margin is where the real story may sit.

Measure	Budget	Actual
Sales	$5,000,000	$5,200,000
Gross margin	40%	35%
Gross profit	$2,000,000	$1,820,000

The business achieved $200,000 more revenue than budget, but generated $180,000 less gross profit. That is why turnover alone can be dangerously misleading.

• Sales

• Gross-profit dollars

• Gross-margin percentage

• Wages as a percentage of sales

• Overheads

• Net profit

• Debtor days

• Cash flow

• Debt

Budget for the Owner Too

There is one cost that sometimes mysteriously disappears from family-business budgets: the owner's financial requirements.

• Pay an appropriate wage to the owners

• Fund tax

• Fund loan repayments

• Replace equipment

• Build cash reserves

• Still provide a return on the family's capital and risk

A family business should not simply exist to keep everyone busy. It should ultimately create wealth for the family that owns it. That belongs in the plan.

The 3P's Future Prosperity Model

PRESERVE

Preserve the wealth the family has already created. A budget should identify whether the business is generating wealth or consuming wealth. Growth that continually requires more personal money, more debt and more working capital without producing adequate returns may not actually be growth.

PROTECT

Protect the business by knowing what must happen financially before problems occur. Know your break-even point, minimum cash requirements, debt repayments, tax commitments, wage obligations and downside scenarios.

PROSPER

Prosper by connecting financial targets to actual business decisions. What needs to happen to improve margin? Which customers should we pursue? Which products should we stop selling? Do we need another employee? Should we buy the equipment? What does the business need to achieve for the owners?

The Three Fixes

1. Build it from business drivers - not last year plus 5%.

Understand what actually creates revenue, margin and cost.

2. Put a cash-flow forecast beside it.

Profit tells you whether the business is making money. Cash flow tells you whether the business can pay its bills.

3. Review it every month.

Compare Budget -> Actual -> Latest Forecast, then make decisions while there is still time to change the outcome.

The 3P's View

A budget should not be an accounting document. It should be a business-management document.

At 3P's Future Accounting, we don't believe the purpose of budgeting is to predict every dollar perfectly. That's impossible. The purpose is to create a financial roadmap, then regularly ask: Where did we expect to be? Where are we now? Where are we heading? And what do we need to change?

Preserve the wealth already created. Protect the business against what could go wrong.

Use the numbers to deliberately build what comes next. Book a consultation today.

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Disclaimer  

This article does not constitute financial advice and is for general information only. It does not take into account any individual’s personal objectives, situation or needs, and is not intended as professional advice. Any similarity to an individual’s personal circumstances and the examples provided in this article is purely coincidental. Any person acting upon such information without receiving specific advice, does so entirely at their own risk.  

Authorisation under an Australian Financial Services Licence (AFSL) is not required in the provision of this article and the author plus Future Accounting Group Pty Ltd is not acting in its capacity as an Australian Financial Services Licence holder 

Liability limited by a scheme approved under professional standards legislation.

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