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Three Most Common Budgeting Errors

Posted on October 15th, 2018

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

When it comes to creating a budget, it’s essential to estimate your spending as realistically as possible. Here are three budget-related errors commonly made by small businesses and some tips for avoiding them.

  1. Not Setting Realistic Goals. It’s almost impossible to set spending priorities without clear goals for the coming year. It’s important to identify, in detail, your business and financial goals and what you want or need to achieve in your business. And a major category to consider is the impact of sales growth.  An unrealistic forecast here will not only give you a false reading of your future funding requirements, but also discredit your business plan with prospective lenders right from the start.

As a case in point, a while back I was working with a client to put together a business plan to assist him in obtaining financing for his company.  I started the process by asking him to forecast his sales for the remaining 3 quarters of the year.

After struggling with it a few days, he came back with a spreadsheet indicating six percent sales growth in the second quarter, nine percent in the third quarter, and twelve percent in the fourth quarter.  And my immediate response was, “OK, now write in the margin, ‘ha, ha.’” (we had that kind of humorous relationship).

“Now here is what I really want to know: What are your customers going to buy from you?  And if you don’t know, call them and ask them.” (In his line of business his customers would know this). When he finally did obtain this information, the projected sales growth far exceeded his initial guess, having major implications for the amount and type of financing he was going to need to fund this growth. (See Testimonials under “Growth Funding”.)

  1. Underestimating Costs. Every business has ancillary or incidental costs that don’t always make it into the budget–for whatever reason. A good example of this is buying a new piece of equipment or software. While you probably accounted for the cost of the equipment in your budget, you might not have remembered to budget time and money needed to train staff or for equipment maintenance.

In addition, you also need to make sure you’ve arranged financing for the purchase of the equipment with the appropriate source of funds, usually long-term-debt.  If you neglect to do this and instead purchase the equipment out of cash flow, you can jeopardize your company’s ability meet payroll, pay suppliers, or basically, to operate.

  1. Failing to Adjust Your Budget. Don’t be afraid to update your forecasted expenditures whenever new circumstances affect your business. Several times a year you should set aside time to compare budget estimates against the amount you actually spent, and then adjust your budget accordingly.

In QuickBooks, there is a budget feature that allows you to create reports with such a comparison. You can project your Profit and Loss as well as your balance sheet and cash flow.  However, projecting your balance sheet is the tricky part, as changes in accounts receivable, inventory, and accounts payable, are a function of your sales growth and turnover ratios , and QuickBooks does not do this for you automatically (nor do most other business plan and projection software programs I’ve seen).

So, I use the QuickBooks budget feature for the Profit and Loss portion only so that I can compare my actual operating results with my original budget. I then export that to EXCEL to be incorporated into a more advanced projection model I use (sample) that can forecast the above balance sheet changes based on historical or expected turnover rates, and in turn, the funds needed to support those changes. I then update the projected data with actual operating results each month so that I can forecast the company’s cash requirement through the end of the year and beyond.

Budgeting and forecasting is not easy for most small business owners who are usually not accounting oriented and have “better things to do” with their time. So as I’ve stated in previous articles, if you need help with it, consider contacting a financial professional.

Related Articles:

Strategic Financial Planning vs. Crisis Management

The Risks of Misinterpreting Your Financial Statements

The Effect of Sales Growth on Cash Flow

The Importance of Cost Accounting in Financial Planning

Analyzing the Components of Cash Flow

The Relationship Between Turnover Ratios and Cash Flow

 


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