Businesses create budgets for a very good reason: to avoid situations where the amount of cash they require for expenses does not unexpectedly go beyond the amount they have coming in. It’s a simple aim in theory, but with an entire business to run and lots of transactions to track, it becomes very easy for entrepreneurs to suddenly find themselves asking, “where has the money gone?”
Budget analysis gives you the ability to spot financial issues early and deal with them before they blow up into big cash flow problems. With this in mind, here are some essential pointers for utilising your budget as an early warning system, with a view to keeping your finances on track.
Why, when, and how to use budget analysis
A simple business budget sets out your actual income and expenses for a defined period. It also includes separate columns detailing the amounts that you estimate your business will incur for the entire period covered. Budget analysis is linked very closely to budget tracking: in other words, monitoring the figures to make sure that your predictions continue to reflect the financial situation faced by your business at any given time.
Businesses with few outgoings and a low volume of customer invoices, often manage their finances with the help of a series of simple spreadsheets. If this is the case, budget tracking is a manual process. Each time money comes in or goes out of the business, this should be added to the relevant ‘actual amount’ section. Each time you do this, it’s good practice to check whether this new entry means you are still on course to stay within your predicted amounts. One of the benefits of using specialist accounting software (as opposed to your own spreadsheets) is the ability to get automatic alerts if you drift too far from these estimates.
Budget tracking tells you if there has been, what accountants refer to as, a deviation (i.e. a difference). This is between actual and predicted expenses or revenues. Budget deviation analysis goes a step further, by showing you where the problem lies. Think of it less in terms of number crunching and more as a means to identify and deal with real-life business issues.
Pick the budget apart
Thorough business analysis is done on a ‘line-by-line’ basis. For example, once you’ve identified a shortfall (or even a bigger than expected surplus), you look at each category of expense and income in-turn, to identify the cause. To help illustrate this, we’ll take a similar approach and look at some of the areas where budget analysis can be most useful to small business owners.
These are the expenses that remain at the same level month-to-month, regardless of your income and level of sales. Because these costs do not fluctuate, they are easy to predict. However, that’s not to say that they shouldn’t undergo analysis and review regularly — especially if your business is looking for ways to reduce a budget shortfall.
Pay particular attention to the amounts you are paying under fixed contracts
Let’s say your monthly IT services subscription bill goes up, for instance. This might be the time to review your needs and shop around for a better deal. You should also review property and machinery lease or licence agreements regularly to ensure they are continuing to deliver value for money.
A restaurant launches a new menu: it’s now full every night and takings are up considerably. However, the budget demonstrates that the business will soon face a shortfall. Analysis of production costs (in this case, the cost of ingredients) may highlight the reasons why. In this example, by comparing month-on-month amounts for the cost of supplies, it may become clear that these have increased more than the business owner had originally anticipated after the change in business direction. Either the business needs to increase the prices charged to customers, or else revise its menu.
Production costs can change
Sensible business owners will do their research on production costs before they set their prices. But these costs can change, a supplier might increase its prices further down the line, for instance. Budget analysis can show you what impact such a development is having on your bottom line. It can also help you keep your pricing structure up to date. Not only this, it will indicate when it’s time to source better deals with suppliers.
Even though you’re as busy as ever, budget tracking might highlight the fact that sales revenue is slipping. Revenue analysis helps you find out the reasons why. As an illustration, by comparing revenue from recent projects you have been working on to previous ones, it may become clear that you are spending a larger proportion of your time on less lucrative work. If this is the case, it might be sensible to revisit your marketing efforts to attract the more profitable type of work.
The earlier you are able to ask, and crucially to answer, the key question “where has the money gone?”, the less of a risk there is of finding yourself struggling with your financial commitments. For further tips on forecasting and business management, head over to our help centre.