Get your head around rands and sense

by Hendri Pelser
Use a budget to help your business perform better, writes Hendri Pelser.

To run a successful business, an entrepreneur needs a good product sold at the right price to a welcoming market.

But, while simply providing a service or stocking goods on a shelf will make you money, it usually will not allow your business to grow quickly and sustainably.

To grow and expand, you need to plan, and that is where a budget comes in. Most entrepreneurs create a budget when compiling their business plan, but the document then gathers digital dust in a forgotten desktop folder.

A budget should be used as a proactive planning tool that is updated and consulted on a regular basis.

What's the point?

According to Christo Botes, an executive director at private SME investment firm Business Partners, putting a few figures together is not a budget.

"A real budget starts with creating a marketing plan and an operational plan, and investigating the economic environment," says Christo.

Many entrepreneurs might cringe at the thought of all this work, but Christo says a budget is a starting point to growing your business.

"Essentially you need to find a way to extend your market share. Only then can you plan how much money is needed to buy new machinery, extend your shop's floor space or hire new staff."

Christo explains that expansion costs money. You need to know what it will cost to grow your business and where that capital will come from.

Different strokes

Creating a budget is not all that difficult. Christo says that business owners need to create two separate, but linked budgets: an annual financial budget and a rolling budget.

At the start of the financial year, you need to create a financial budget that forecasts the business's performance for the next 12 months. The figures used should be based on your past performance, current and expected market conditions and any expansion plans in the pipeline. Essentially you are creating a plan to follow.

But reality comes with its own surprises, and that is where a rolling budget comes into play.

Christo says a rolling budget is simply one that is updated continually to take new events and market changes into consideration.

"A budget is also not for your bank manager - it needs to work for you and your business.

"A budget needs to be constantly adapted because business changes every day. A budget is based on your overall business strategy and needs to be informed by it."

How it works

The point of any business is to make money, so the starting point of any budget is expected income.

As a result, you need to calculate expected sales carefully.

"These figures can't be pulled from the air and need to be substantiated. Look at your share of the market," Christo advises.

"If your business is new, you must accept that it will take time to get sales coming in, and competitors will come down on you hard.

"Your cost of sales and gross profit margin will be determined by your strategy."

He adds that almost any business will sell either low-volume, high-margin goods or high-volume, low-margin goods.

As a result, you need to sit down and think about your overall business strategy, what you are selling, the price you are selling at and the opportunities to gain market share.

There is a cliché in the business world that anyone can become a millionaire on an Excel spreadsheet, so business owners need to be realistic when compiling sales forecasts.

Some entrepreneurs can go even further to create three separate forecasts for pessimistic, realistic and more optimistic future scenarios.

It takes money to make money

Sales forecasts are all good and well, but it takes money to make money.

As a result, your turnover and gross profit will determine everything else, like how much shop space you need, how many employees are needed or how much electricity you will use.

In other words, if you want to grow your turnover and profit, you might need another office machine or another 20m² of retail space.

Creating a budget will allow you to see if your projections are achievable.

Maybe the machine you have in mind is simply too expensive and will not generate enough money to pay for itself, eating into your cash flow.

In a nutshell, income and expenses go hand in hand, and Christo says your estimated turnover projection must be based on realistic expectations.

"Do your market research and speak to your biggest clients to see if they will support you or where you can expand on the products or services offered to them."

Christo adds that once business owners are able to get their budgeted figures to between 70% and 80% of the actual amounts, they are on the right road.

"A budget is your estimation of what the reality might be. Without it, you are sitting in the dark and without direction. A budget helps to plan for the road ahead."

Be realistic

Basically a budget is a financial representation of a business plan; it is a planning and evaluation tool.

For example, if a clothing retailer wants to increase turnover, he can either expand the shop to stock more product lines or add shelves. Both scenarios cost money, and a budget will give you an idea of what the best strategy might be.

Once the plan is being executed, it needs to be evaluated, and a running budget will show you if the reality and your initial projections are matching up. If not, adapt your budget and roll-out plans.

Christo says that a clothing retailer might find that people are buying seasonal items sooner than expected. As a result, he needs to restock quickly or lose out on sales. "The bottom line is the bottom line, and this is what your budget will show you.

"As an SME, you cannot take a shotgun approach to sales or marketing - you need to take out specific targets. Use key ratios and industry norms, as well as your specific situation. If you see that your projections are way out, use the running budget to adapt to this reality. You can't usually change your profit margin, as you will price yourself out of the market - it's better to change the products on offer."

Useful resources:
Sunday Times
The Sunday Times is South Africa's biggest-selling national newspaper. Includes Sunday Times Magazine, Lifestyle, Business Times and Metro sections.
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