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There's a Lot You Can Get Wrong With Business Budgeting... But It's Still an Invaluable Practice
According to one recent study, only about two-thirds of all businesses that open today will survive two years in operation. Roughly half of them will last approximately five years. When you get to 10 years out, that number drops to one-third, according to the Bureau of Labor Statistics.
Fascinatingly, a massive 82% of all organizations that end up failing do so for essentially the same reason: cash flow issues. Cash flow doesn't just refer to the total amount of money coming into an account. It also refers to the timing of that money, among other factors.
Invoices don't get paid when they should be. Loan payments come due before the cash is in an account. All of these things take their toll, and businesses of all sizes pay the price because of it.
That, in essence, is why business budgeting is so important. You need to be aware of what is going on in the short term, yes, but the long term is far more important. Obviously, you have goals that you've set for yourself that you're trying to accomplish, whether it's expanding to a new location, purchasing new equipment, or hiring more employees. But you need to make sure that you're financially in a position to do that, and business budgeting is how you do it.
The Importance of Business Budgeting
Of course, people can make a number of mistakes when it comes to business budgeting that can be truly detrimental in the long run. Case in point: simply assuming that last year's budget is applicable to this year, which is rarely the case.
Never forget that last year's budget was based on an entirely different set of circumstances than what you are currently facing. In the best of times, businesses are supposed to grow and evolve -- they're naturally going to need more money to do it. Not only that, but consider if you had attempted to use 2019's budget as a basis for your 2020 projections, and then something wholly unexpected like the COVID-19 pandemic hits. It would throw everything into chaos in a way that would make it difficult to pivot from moving forward.
The same concept is true whenever there is an unexpected change in consumer purchasing behavior, something that has happened before and will absolutely happen again whether you like it or not. For example, say there is a company that makes products that somehow significantly underpredicted the demand they would see for the holiday season. The reason for this might be as simple as a manager wanting to set a budget goal that he or she knew they would be able to hit. But once that budget was set, it created a ripple effect throughout the entire company; demand was based on that sales forecast, production was operating off of it and more. A significant amount of money is left on the table, all because that manager fell into some of the worst practices of business budgeting there are.
Another big mistake that a lot of small businesses in particular make involves not basing their budget on anything practical, meaning they're not using the data in front of them to make more accurate estimates for what is to come. Simply estimating expenses versus income based on gut instinct and "intuition" will likely lead to going way over budget in the new year.
Instead, what you need to be doing is looking back at that historical data to see what trends and patterns you can uncover. When were the busy periods of the year as opposed to when work slowed down? What are your current goals, and what do you need to accomplish them? These are the types of questions you need to be asking yourself for the best possible results.
One practice to get in the habit of when setting a budget involves listing out three key things: your projected sales for the upcoming year, any fixed expenses that you have such as rent for an office or equipment and things of that nature, and variable expenses. Then, you can contextualize things and begin to get a sense of how much you need to accomplish exactly what you want.
Finally, another major mistake that a lot of organizations make involves forgetting to take the money they're making and reinvesting it where it matters most -- in the business itself. Again, the goal of any organization is to grow -- you always want to push yourself and be more successful and reach more people. When a company is under budget, there is often the urge to take those excess funds and set them aside.
To be clear, using that money to pay down things like business loans or to create some type of "rainy day" emergency fund isn't a bad idea. But with proper business budgeting, you can take that money and put it back into other areas of the organization where it can do the most good.
On at least a monthly basis, organizational leaders should be seeing how much in the way of leftover funds that they have, and they should be thinking long and hard about what they can afford to put back into the business itself. That way, you're not missing out on key growth opportunities and are instead capitalizing on them at every opportunity.
In the end, business budgeting is an important part of running any organization, but it's safe to say there is a lot that can go wrong with an incorrect approach. You need to understand the situation you're in, where you are, and where you're trying to be next year or even five years from now. Only then will you be able to glean as much valuable information from this process as possible, thus allowing you to make the best decision possible at the moment.