Do you currently create budgets for your company? Do you produce spreadsheets that show expected sales each month for a year or even multiple years into the future? Do you also show your expected costs associated with those sales and the overhead you anticipate? What about investments like R & D or equipment? Do you budget for those?
If you said yes to some or most of the above, you are better positioned for success than many of your competitors. If you said no, your competitors are potentially much more efficient than you are, and will dominate you in the market, even if you are better at what you do otherwise.
Bonus points if you do cash flow analysis, which is a form of a budget. Your cash often goes out for materials, labor, rent, etc., days or months prior to revenue arriving. Do you have a forward-looking cash flow analysis that will show you, in advance, where you might have shortfalls?
The use of budgets creates an early warning system that something is off track. If you are budgeting sales of $100,000 a month and the cost of goods at 50%, then you would be budgeting $50,000 per month in purchases. If your purchases are $80,000 in one month, this should be a reason to find out why. Otherwise, you are going to be faced with paying your suppliers for those goods without enough incoming revenue to maintain a balanced cash flow. It may turn out that you only bought $30,000 the month before, and are only going to buy $40,000 next month, so all is well. However, it may also turn out that your buyer is “doing you a favor” by buying huge amounts at sale prices. That might be okay, but you’d want to know about it before you end up unable to make payroll.
Sales budgets are particularly useful. You may want to make three sales budgets. Worst case, likely, and optimistic. By doing these three budgets, you can fill in the costs and overhead to see what will happen to profits, cash flow, and inventories. It may also provide some instruction on how to plan your labor.
Budgets are generally produced based on years of historical information about each line item on the budget. If you have not maintained detailed Profit and Loss statements, you can either go back and create good spread sheets from your books, or if your books have not been that great, you can start now with a better system of gathering and reporting data.
For more information on budgets may I recommend “Making Money Out of Thin Air” The book was created as a simple, easy to read and understand, a primer on setting up great books and using them to make a profit.
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