Budgeting: it’s a good financial discipline and in 2022 it’s in vogue 

With the economic climate continuing to be uncertain with multiple factors impacting the short and medium term outlook, it is more important than ever to have an annual budget in place for your business that you review regularly.  

Knowing where you are at financially and where you headed, and where you may be headed if course adjustments are not made, will help you to be certain about your plan for the year ahead and setting financial targets when future trading conditions are difficult to predict. 

The most important thing we know about the future is that it is unpredictable, so to plan for this we need to look at a range of scenarios that should, could and might occur. 

Our financial thinking should cover the things we know now that we will or may need, and it should cover the things we do not yet know we may require in the future i.e. those things that might just happen if certain situations and factors arise.  

Post Covid, we have all become a little more accustomed to considering – and having good fall back and contingency plans – potential course changes to deal with the unexpected.  

The strength of having a range of considerations in your annual budget and looking beyond this to look at the things that might just happen if certain conditions are created and opportunities realised is that it will give you options and choices to consider. 

It is knowing your potential options and investment choices that it gives you resilience and robustness for the future.  

Looking ahead, will help you to spread your risks when making financial decisions and it will lessen the likelihood of your chosen options failing or underperforming. 

Businesses have had to adapt and become more agile in order to react quickly to changing market conditions and budgets should be created with this in mind. 

Start with your fixed costs. The things that you can be certain of such as premises, staff costs, raw materials, light, heat, electricity, IT, etc. Next, turn your focus to the longer term aspects of your budget with an analysis of existing strategic or capital spending plans. 

Stress-test the assumptions, scenarios and decisions that have gone into your draft budget. What if your sales don’t grow next year? What if your income falls because 20% of your customers leave and go to another provider? How does this affect the profitability of the business? What if you are locked into a three year contract on price but your input costs have risen by 10% (or more)? 

In uncertain times, it is important to be pragmatic. Create 3 scenarios for your budget – top, middle and bottom.  

Start with the middle scenario – the “expected” outcome and from there you can derive variations on whether things turn out better (top) or worse (bottom). 

Scenario-based budgeting is not intended to predict exact outcomes. Instead it is intended to help the business to understand the likely variances and to prepare and plan accordingly. 

You should consider holding back some spending centrally as a contingency. This builds some flexibility into the budget so that the business can react to changing circumstances as the year progresses. 

You should always calculate your budget using new data, not historical projections. Budgets may have been squeezed in the past 18-24 months and may not reflect the current or predicted market trends. 

Finally and most importantly, build realistic income models. Ensure you provide for bad debts and write offs in each of your top, middle and bottom scenarios. Cash is king and in uncertain times every business must focus on getting cash in on a monthly or even weekly basis. Billing cycles and cash collection management should be at the top of the agenda for the management team and offering extended payment terms to customers should be avoided as much as possible. 

Build these principles into your budget and ensure you keep adequate reserves in case you encounter headwinds during the year ahead. 

Please talk to us about budgeting and cash flow planning (see side panel) for the next few months, we can help by providing you with Xero/Syft analytics software and give you the guidance to get started so that you can do it yourself or we can work together with you to produce your business budget and plan for the year ahead.