Your Business Has a Budget. Does It Have a Plan?

The budget shows sales increasing, costs under control and a better profit at the end of the year.

On paper, it looks great.

But ask where the additional sales will come from, how the business will deliver them, or what cash will be needed along the way, and the answers may be less clear.

“We need the sales team to push harder.”

“Production will have to improve efficiency.”

“We’ll manage the cash flow as we go.”

Those statements leave some important decisions unresolved. Yet the budget can still be approved, circulated and used to measure everyone’s performance.

The numbers balance. The business behind them may not.

A budget brings the financial expectations together. To assess whether those expectations are realistic, I would want to understand what management intends to do to achieve them.

Consider a business budgeting for a 15% increase in revenue. That is an illustrative target, but the questions it raises are practical ones.

How much of the increase will come from higher prices? How will increasing prices impact the current customer base? How much depends on selling more to existing customers? How much requires the business to win new customers?

Each answer requires a different approach.

A price increase depends on what customers will accept and what happens to volumes afterwards. The increase in price may offset any potential loss in customers. Or it may not. Additional sales to existing customers depend on their demand and your ability to increase market share. New customers require a credible pipeline and enough time to convert opportunities into orders.

Applying 15% to last year’s revenue does not answer any of those questions.

The timing matters too. A customer expected to start buying in July cannot support the same annual revenue as one placing orders from January. If the budget assumes a full year of sales while the sales team is still negotiating, the problem exists before the first monthly variance report is produced.

Then there is the question of delivery.

Suppose the business does win the additional orders. Can it fulfil them with its current people, equipment and processes?

An overall capacity figure can hide a constraint in one part of the operation. There may be room to produce more, but only if a particular machine runs for longer, a skilled employee or team is available, or a supplier can deliver a critical component on time.

In a service business, the constraint might be the senior person who reviews every assignment. Hiring more junior staff will not necessarily increase the volume of work that person can review.

If the sales budget assumes more volume while the cost budget assumes no additional capacity, I would want to know what will make that possible.

Perhaps there is a genuine opportunity to improve productivity. If so, what is causing the lost time now, what will change, and when should the improvement become available?

“Improve efficiency” may require a review of operational processes, and the ability to identify inefficiencies. It may also require additional cash to improve machinery or train employees before meaningful changes can be seen.

The same applies to cash.

Additional sales may require stock to be purchased or manufactured, and salaries to be paid before customers settle their invoices. A business can achieve its sales target and still find itself under pressure because the cash needed to deliver those sales was underestimated.

Supplier terms, customer payment patterns and the time between purchasing and delivery all affect how much funding is needed, and when.

If the plan depends on an overdraft increase, that funding should not be treated as available simply because the spreadsheet needs it. Also, borrowing has a cost – interest that needs to be factored into the calculation. What happens if the additional funding does not materialize?

This is why I would work through the budget with the people responsible for sales, delivery, procurement and finance together.

The useful discussion is in the connections between their assumptions.

Sales may expect shorter delivery times to win more work. Operations may need additional stock to provide those turnaround times. Finance may be expecting stock levels to fall to release cash.

Each expectation can sound reasonable on its own. Like a puzzle, they need to come together in a coordinated way before the business may be able to meet its targets.

I would start with the few assumptions that could materially change the outcome: the new customers, the price increase, the capacity improvement, the collection period or the funding facility.

For each one, determine who needs to act, and when it needs to happen. Then consider what the impact on the business would be if it happened later than expected or did not happen at all.

That gives management something useful to revisit during the year. A missed target can be traced to a particular assumption or decision, rather than becoming another instruction to work harder.

Before approving your next budget, choose the most important change.

Can you explain exactly what the business needs to do to deliver it, what resources it will require, and what you will do if the key assumption proves wrong?

If you cannot, does the budget really add value?

At ZM Advisory, I work with business owners and management teams to connect financial planning with the commercial and operational decisions needed to improve performance.

Better Decisions. Better People. Better Performance.