3 Problems That Break Business Budgets
Just like misreading a map, your company can end up in an unfamiliar place when budgeting is done incorrectly – or worse, not at all. So how do you make sure your budget keeps your business on track and provides accurate “directions”?
In my experience creating and reviewing budgets, I’ve noticed three items cause most problems. Avoid these common errors and you’ll likely keep your company’s finances on course.
The budget isn’t reviewed on a regular basis.
The beginning of the month is a good time to gather your management team and review sales and expenses for the previous month. If you have a CFO, he or she should do this independently and call your attention to any red flags. Start comparing these numbers versus your budget to look for variations and gauge performance.
Begin your review at the top – are your sales figures in line with your forecast? Are your costs of goods sold what you expected? If either your gross profit or your gross margin is significantly lower than forecasted, determine whether this is a blip on the radar or the beginning of a trend – and then discuss your options for action. Use this checklist as a starting point on a monthly basis.
Your operating expenses are budgeted based on what you have in gross profit. So these figures are critical to keeping your budget on track.
If you hit these two numbers, you’re likely in pretty good shape. If there’s a variation, then get a little more granular and figure out what’s happening.
(NOTE: If you stretch this review to quarterly, do so with much caution. Cash flow troubles can escalate quickly over three months.)
Your cost of goods sold are out of line.
Let’s say your budget for a project is $1 million and you’re partially complete. If you forecast your remaining expenses and expect the total project cost will be $1.5 million, you have a serious problem that needs addressing now.
Is it worth just bailing out of this contract? Can you recoup some of these expenses via change orders or modifications to your contract? Did you price this project wrong or did something change drastically from what you expected? What will be the repercussions if you back out to save yourself from deeper losses or even bankruptcy?
Putting off these decisions only intensifies your problems and can bury your company quick. So keep a good handle on what it costs you to fulfill sales orders, build a project or complete whatever your business does.
Payroll isn’t used effectively.
For most businesses, payroll is the greatest operating cost. If your gross profits are not what you expected through the first quarter of the year, it’s time to assess if you need to trim payroll or have contracts ready to sign in Q2 to make up for a lousy Q1.
Alternatively, perhaps you have a $100,000 payroll budget, but the people you pay aren’t giving you the best bang for your buck. You may not need to cut payroll. You may just need better people to get the results necessary for the money you spend. Of course, this is a different way of looking at payroll, as opposed to just seeing it as a line item on a P&L (profit and loss statement).
Consistently review performance so you know whether your employees are doing what they should for what you pay them. Always have a sense of what the market rate is for your labor needs.
When you stay on top of these three problems, your budget turns from an obstacle to an opportunity for meeting performance objectives. And remember, it all starts at the top. If your gross profit and gross profit margin are on target (or better than expected) you have options. Be sure to review at least monthly to spot trends before they become another fire you have to put out.