A financial plan (normally called a budget) is vital to support a business achieving its financial goals. Budgets allow you to track results against your financial goals, enabling reactive decisions as time goes by to keep on track! However many businesses make common budgeting mistakes which impact the effectiveness of their budgets.
These mistakes include the following:
Only budgeting the profit & loss
Knowing your expected profit or loss is important, but equally as important is creating a cash flow budget. Why? You need to understand if your expected cash flows ensure you have the money available to settle your debts at all times across the year.
Timing is critical with cash flow due to periodic payments such as tax bills, and the timing of your income against receiving the cash can be very different dependent on your customer payment terms.
Knowing your business has the cash to survive is vital!
Not tracking actuals against your budget
Some businesses don’t look at the budget again after it’s created! This is one one of most common budgeting mistakes made! Constant monitoring against the budget is useful for two reasons:
- You track actuals against the budget to ensure you understand whether you are on track to achieve your goals, and make reactive decisions if not
- It helps understanding what needs to change in your assumptions to improve future budget creations
Only creating one scenario
Only creating one scenario of a plan means you’re not considering the implications of changes in your key business drivers. Consequently this leads to reduced insights on which drivers have the largest impact of financial performance and should be closely monitored. This reduces your chances of reacting effectively and quickly to resolve problems.
The benefit of creating a variety of versions (normally at least 3) is that you can understand the likely range of financial results achievable for your business. This understanding of the range enables you to set a more realistic target.
Key drivers to monitor as variables include:
- sales volumes
- pricing changes
- profit margin variations
Not considering the business strategy
Smaller businesses may not have the experience in creating financial plans and budgets. This means they do not consider the short to medium term goals of the business when creating their budget and make individual assumptions instead of tying the budget together.
Not updating the budget
Decisions within your business and externally (i.e. political) can impact your financial results and expectations against your budget. If factors change significantly you should update your budget with this new information, to understand the financial implications. For example, corporate businesses normally re forecast their budgets 2 or 3 times a year to keep up to date.
Missing key information
Budgets created using historical data due to ease of information, or with no input from other departments, lead to inaccuracy. In other words, missing key information relating to business drivers, income and costs creates an unrealistic budget.
Setting unrealistic targets
Business owners are usually optimistic around their sales targets. Being unrealistic however ruins your chances of achieving your financial goals. Staff confidence and motivation evaporates quickly with tough targets that are difficult to achieve. Your budgeted cost base will also be too high, and will be difficult to claw back. Effective sales targets are created with historical data, market and competition trends.
Underestimating your cost base
There are a few main reasons why costs are under budgeted for:
- inflationary increases are not factored into your costs
- taxes are excluded from workings (payroll taxes, corporation tax and vat)
- irregular expenses are forgotten
Not including a contingency fund
You want an accurate budget, but there’s always something unexpected that happens! Including a contingency fund gives you some room for manoeuvre if this happens. If it doesn’t then you’ve got a greater chance of beating your budget!
It’s important your budget is as realistic as possible, to give you the best chance of achieving your financial goals, keep staff engaged and motivated, and also ensure your cash flow is well managed. Make sure you remove any of the common budgeting mistakes by businesses noted above to achieve that realistic budget!