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Budgeting

Managing Business Expenses

Understand the various financial components of business that are intertwined with each other and impact they can have on the operational decisions made by the business.

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Business Finances

The term business finances refers to the assets, liabilities, capital, revenue and expenses of the business. For you, “expenses” may or may not literally include taxes, but however you want to slice it, taxes and tax considerations obviously have a big impact on how businesses are organised and run. These financial components are tightly intertwined with each other and with the operational decisions made by the business.

1. Capital Purchases & Assets

Almost all businesses need to acquire and use fixed assets. The acquisition can be through purchasing, renting or leasing. Purchase and lease decisions in turn require ROI analysis and financing decisions. Then, once an asset is acquired, it must be recovered, or expensed, over time to reflect its depreciation and plan for its replacement. The financing and cash flow decisions involved in acquiring assets will affect both business operations and owner finances, especially in proprietorships, partnerships and closely held corporations.

2. Capital Structure

Capital structure refers to how much of the business financing is through owner equity and how much is through debt or other liabilities and how it is done, that is, the mix of financial instruments and ownership vehicles. Business capital requirements and owner decisions influence the capital structure, which in turn influences the owner’s personal finances. Entrepreneurs must decide how much of their own capital to invest in the business, how they will be “paid” for that capital (in profits, wages, interest, or other ways) and how procuring capital through loans will affect their own financial well-being.

3. Working Capital

This is a tough concept for many entrepreneurs to grasp. It is capital used to finance the flow-through, what goes into the business and what goes out of the business – not the fixed or tangible assets of the business. It is used to pay for inventory and to provide cash for other items necessary for the day-to-day running of the business. Any business that must pay a supplier or an employee before providing a product or a service to its customers or must provide a product or a service to customers before receiving payment needs working capital to make this happen.

Working capital is part of the total capital required to run a business – and the most dynamic part. Insufficient working capital can choke business operations– insufficient inventory, inability to offer satisfactory customer purchase terms, inability to pay employees or suppliers. It is very common for entrepreneurs to underestimate the need for working capital. The usual result is that the owner must kick in more capital from personal finances– or accumulate more debt. Working capital mismanagement is a common cause of personal financial failure for entrepreneurs.

4. Cash Flow

This is the bigger picture for working capital. Does the business have enough cash to meet its ongoing business needs? Does it generate enough cash through operations to replace assets, pay its owners, and fund its growth? Poor cash flow leads to inadequate business resources. It can cause many financial problems, from decreases in owner returns to severe shortages of capital that must be met eventually by the owners.

Cash flow becomes especially critical when the owners must replace key assets or as they’re implementing important growth and competitive strategies. Many a business has declined or failed because of inadequate cash flow to replace assets or to execute key competitive strategies.

5. Risk Management

We mentioned risk under Business Operations, but any business faces various financial risks. Customers don’t always pay, interest rates don’t always stay the same, tax rules change, sources of funds don’t always come through as expected, owners or investors can leave and the list goes on – all with obvious personal financial consequences.

Business Operations

As an entrepreneur you will make hundreds to thousands of operational decisions in setting up an infrastructure and producing your product or service.

All decisions that involve money involve the finances of the business, of course, and many, like employment and facility decisions, will affect your personal finances as an owner. And these decisions are never finished, they will adjust and evolve as your business evolves – and so will your business and personal finances. Business operational decisions include the following:

1. Employment & Employees

Whether to have employees, how many, and what kind of compensation to provide are decisions that affect business finances in obvious ways. Decisions about employee benefits and retirement plans will affect you, for whatever you decide to do for them may have consequences for you: You can participate in benefit and retirement plans, often to your advantage. Also, your decision on how to engage yourself and your spouse and/or family members as employees can impact your company finances.

2. Facilities & Location

Early on, you’ll have to decide what kind of location and building your business needs. That decision will probably have to be modified as the business grows and evolves. Naturally, like employee costs, facility costs are a major factor in the finances of most businesses. But key decisions on building ownership– buy vs lease, owner buys and leases to business – are important for personal finances. Depending on the business, many entrepreneurs look to buy their facilities to build the asset base as part of a retirement or other exit strategy for the business. In addition, the use of a home or other personal space in a business has important personal finance consequences.

3. Growth strategy & Plans

Every viable business has a strategy and a plan to grow and evolve. Decisions on how to evolve and how fast must be made in the context of both business and personal finances. Many good businesses fail because they grow beyond the asset base and working capital required to support them.

4. Organisation

Every entrepreneur must decide how to organise his or her business. Not only are we talking about organising facilities and human resources, but also the basic legal structure of the business. The decision of whether or not to incorporate is important. If the decision is not to incorporate, important decisions must be made between or among partners, if there are partners, and contingency plans must be in place in case things change. Like most operational decisions, the organization decision is never finished.

5. Risk

Every business has risk and there are several kinds of risk. Operational risks – the risk of accident, mistake, or omission – produce potential liability for the business and can produce liability for the owners, depending on how the business is structured. Continuation risks concern the ability of the business to function in the case of unexpected catastrophe or unavailability of a key employee or owner. Financial risks concern the capital structure and the availability of capital and are covered below. Many of these risks are assumed and covered at the business level, but the owner must consider the risks at the personal level as well.

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Budgeting

A Strategic Approach To Enterprise Cost Reduction

During periods of uncertainty, companies that take bold action can recover more quickly and gain sustainable competitive advantages that boost performance both in good times and bad.

Daryl Elliot

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Companies in South Africa face a number of challenges that include slow Gross Domestic Product (GDP) growth, high unemployment and uncertainty associated with the current political environment. The tsunami of change driven by digital disruption as a result of the fourth industrial revolution has spread across the continent, potentially reshaping the competitive landscape in all regions. To tackle these complex and varied challenges, many South African companies may need to pursue cost reduction more aggressively.

Overall findings in Deloitte’s Strategic Cost Reduction Survey launched earlier this year found that South African companies cited “macro-economic concerns and recession” as a top external risk much more frequently than the European Union (EU) average (59% versus 34%).

Compared to European companies, South African companies posted worse historical results with over 40% of respondents stating that revenue has either remained the same or decreased over the past 24 months.

The survey found that the dual margin approach has been the norm for South African companies with cost reduction targets set very high and even higher cost program failure rates. One question to ponder is whether executives in the South Africa have subconsciously accepted the barriers and scaled back their cost reduction actions accordingly – even if a more aggressive approach to cost management could help their businesses thrive? During periods of uncertainty, companies that take bold action can recover more quickly and gain sustainable competitive advantages that boost performance both in good times and bad.

Re-examining the strategy

Before designing a cost reduction programme, make sure your overall business strategy is still relevant within the current  environment. Organisations transform their business for different reasons. Some are positioning themselves for new growth opportunities while others are restructuring to improve efficiency and reduce costs. What they have in common is the desire to dramatically improve their business performance.

Related: Symantec Calls for 80% Reduction in Operating Costs

Cost reduction programmes are commonly carried out in silos, without much more coordination than each having some portion of an overall rand target to meet. The task then becomes so complicated and fraught with sensitivities that little happens in the way of sustainable efficiencies. But it needn’t be so. If you go to the trouble of mobilising for cost reduction, you might as well make it stick, and create some competitive advantage along the way.

Traditionally, a company bases its strategy on its best prediction of what events could affect its business, and when. But in a fast-changing business environment, you need an approach that doesn’t require you to pretend to have a clear picture of the future. One way to do this is to define a range of scenarios of what the future may hold. Then, develop the best strategy to respond to each scenario. Initiatives that make sense only for certain scenarios become your “contingent strategies.” Once you formulate the core and contingent strategies, your cost reduction program will have to be just as flexible.

Establishing a cost base

A cost reduction programme is only as good as the data it’s based on. You need detailed cost data to identify which factors are driving business costs, as well as to justify cost reductions. The next step, therefore, is to figure your current cost baseline. The cost baseline indicates the costs you would incur if you took on no new cost reduction initiatives and with a cost baseline, you can measure the effect of your cost reduction programme by comparing actual costs to the expenses that would have occurred without it.

Start by updating the current year’s budget to reflect any new efforts, such as staff changes or the introduction of new products. This is a good time to cancel anything that cannot be resourced or no longer supports your strategy. Next step is to analyse your costs and headcount by business line, function, and location. Clearly state any rules for allocating centralised functions or shared services to individual lines of business.

While you’re doing this, try to figure out how your business came to have the cost structure it does. It probably is a product of many leadership regimes and acquisitions. Understanding the history can help you identify promising areas for cost reduction. Assess how each areas performance compares to that of best-practice organisations. If there’s a gap, determine how much you’d need to improve in order to close it. At the end of this project, you should have a decent sized list of potential cost reduction initiatives.

Set Cost Reduction Targets

One way to establish cost reduction targets is to try looking at them from several perspectives, such as:

  • Contribution to Strategy – How the initiative will affect your strategic goals and impact on business Continuity.
  • Investor View – This is how much cost cutting you need to do to support your current share price, assuming revenues stay flat. If you look at cost reduction from all three perspectives, you can triangulate them to set a cost reduction target that’s both achievable and acceptable to investors. Competitive View – Tally how much you need to save in order to become as efficient as the top performers in your industry. Knowing what your peers have achieved can give you an idea of what you can achieve.
  • Operational View – Looking at each line of business to identify potential cost savings, and then aggregate them across the company.
  • Ease of Implementation – Identifying whether there are any technical or cultural obstacles to implementation and how you deal with them?
  • Risk – In terms of how significant are any implementation risks?

Companies that are able and willing to make bold cost moves could find that the current economic environment is a prime opportunity to position themselves for long-term success. Tactical cost actions alone will likely not be able to deliver the required level of cost savings. Companies need to adopt new approaches to cost management, shifting to actions that are more strategic and structural, such as increasing centralisation, reconfiguring the business, and outsourcing/offshoring business processes.

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Budgeting

4 Ways To Improve Your Budgeting Skills

Increasing revenue isn’t solely dependent on how much money your business is making but also relies heavily on how well you manage it.

Josh Althuser

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Traditional budgeting methods have undergone a digital makeover in recent years, and now offer businesses an abundance of streamlined services, tools and access to experts that will help improve your budgeting skills. From regulating current expenses to applying for funding, a well-crafted budget is an essential part of developing a healthy financial forecast for any business.

1. Take advantage of budgeting software

Creating an effective business budget will require a bit more than just utilizing a personal financing software. Luckily, there are plenty of tools available that focus on helping you get your professional finances in order. Centage, which came out in 2001, is a powerful portal that gives companies the chance to streamline their budgeting, while also providing forecasting and consolidation features to help you create more strategic budgeting plans. Investing in a budgeting software is a great way to stay organized at any stage of your professional development.

2. You can’t predict the future, but you can prepare for it

In addition to making the most of the available budgeting tools on the market today, it also pays to do your research. Understanding market fluctuations, as well as competitor activity, will help you create a clear budget plan based on these variables. Keeping up to date on the changes that tend to happen frequently within your industry will also grant your business a bit of extra confidence when it comes to making future decisions. Budgets can provide a strong financial forecast help businesses adapt quickly to changes that might have set them back in the past. For example, if your product is largely dependent on seasonal trends, these projections will give you a greater sense of which months you will be seeing more revenue, allowing you to allocate these funds accordingly throughout the year.

Related: It’s Vital To Your Business Success: How To Manage Your Budget Better

3. Ask an expert

Creating an effective budget for your business goes way beyond simply organizing your finances. Reaching out to an expert to help you construct a budget that fits both your personal and industry needs can better schematize your current plan, and potentially make your business model more profitable.

The rapid growth of the freelance economy has resulted in the creation of platforms that give businesses, big and small, access to a wealth of skilled finance professionals. Whether you’re in the market for a quick consulting session, or on the lookout for a long-term advisor, speaking with someone who specializes in creating budgets for business is a great way to gain valuable insight on the best ways to handle your finances. 

4. Don’t forget about funding

Access to funding is an important resource for any business, especially those that are in the early growth stages. Whether you are starting out small with a modest self-investment, asking friends and family for a bit of help, or preparing to pitch a big name investor, having a financial forecast in place is a must.

For those that are hoping to get their hands on VC funding, presenting current activity and future financial projections is an essential part of the process. Of course, investors understand that budgets are subject to change, but without a financial plan in place, investors may question whether or not your business is a worthwhile investment. A clearly constructed budget can help illustrate the value of your company, in addition to showing what will be done with supplementary funding to increase growth.

Related: 7 Ways To Be Debt Free For The Rest Of Your Life

For small and big businesses alike, an agile and well-crafted budget is key when it comes to maintaining and improving your company finances. From managing the day to day expenses to preparing for unexpected changes in the market, getting into the habit of good budgeting is the best way to ensure steady growth for your company.

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Budgeting

It’s Vital To Your Business Success: How To Manage Your Budget Better

Should I take budgeting seriously, and what can it do for me?

Ed Hatton

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A budget is or should be a part of your business plan. It is one of the major control methods to make sure your plan is implemented rather than ignored.

I agree that there are some very successful businesses that operate on a seat-of-the-pants basis, but there are a lot more trying to do so but instead floundering around in the dark.

Unless you are gifted with unerring judgement and great insight you are likely to achieve more success by working to a plan and budget.

Budgets are often prepared by financial managers and tend to focus on operating and capital expenditure rather than sales, purchases, inventory and debtors targets. A better approach is to start by agreeing what performance your company would like to achieve for all key areas.

Related: 6 Simple Ways To Build Brand Credibility On A Tight Budget

The sales budget could be a separate section of the main budget to manage expected sales by whatever breakdown suits your business: Type of product, by division, branch or sales channel, or type of customer. In each category budget for margins, discounts and commissions.

Correctly managing your expenses

expenses-for-businesses

Key expense items like payroll, overtime, marketing promotions, travel, vehicle expenses and IT costs should be planned for and monitored via the budget but I suggest you don’t clutter the expense budget with too many items which you have little power to manage.

Rather lump these together, you can always drill down if the costs get out of hand. If you have a seasonal business with variations in sales and expenses depending on the time of the year, make individual budgets per month.

Do not forget balance sheet lines, especially capital expenses for new buildings, machinery or vehicles, and also borrowings and other liabilities.

Related: 5 Budget Pitfalls To Avoid In Your Business

Debtors, creditors and inventory should all be planned and monitored and it is a good idea to monitor measures like average days outstanding for debtors and creditors, days inventory held, bad debts and obsolete or lost stock.

The last items can be target ratios which may not form part of the budget, but should be reported on regularly so that you do not get nasty surprises at the year end. Prepare the budget with everyone concerned to get buy-in. The budget becomes an agreed plan of operations to which everyone is committed.

Continuously review your budget

budget-review

Monitoring performance against budget should be done at least quarterly, but I prefer once per month in a management meeting. If you are the only manager, set aside time each month for a vital review your performance against budget.

The actual results must be up to date and available. Use a simple spreadsheet showing budget, actual and variance or a dashboard which shows key metrics as graphics or tables.

Examine those items where the variance to budget is significant and probe for reasons. The dangerous ones are the start of a trend — for example sales in one area consistently below budget or mushrooming overtime costs.

For any bad variances that are not just a short-term hiccup you should plan to correct the problem, or if the problem is insurmountable, replan to get around it.

Course correct your budget as you grow

The budget can be changed because circumstances are different to those envisaged when the budget was prepared, but a better option is to add another column for a revised budget, so the amount of the change remains obvious.

Related: 7 Creative Strategies For Marketing Your Start-up On A Tight Budget

Managing the budget should not be limited to complaining about excessive entertainment or travel costs, but a vital tool to give stark visibility to key areas of the business that are not performing as expected.

It should involve all the key players in decision-making to catch and fix problems early, but also to seize opportunities presented by better-than-expected performance at the earliest time.

Treat budgeting as a management tool and it is likely to treat you to more profit and less nasty surprises.

Do this

An excellent way to increase profits is to treat budgeting as a management tool. Never be scared of your budget — use it instead.

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