A budget (or pro forma) is a great tool to help you determine whether your business meets your profit requirements, given reasonable assumptions. If you can't pencil it out on paper, then odds are the business model needs a re-haul.
Tracking actual-to-budget provides visibility into whether you are meeting your revenue and expense goals. Reviewing this on a monthly basis allows you to course correct mid-year. For instance, if expenses are higher than expected in one category, then perhaps you can compensate by reducing costs in another area.
Lastly, many business owners find it useful to update their budget every month with actuals and then reforecast the rest of the year. This provides an up-to-date projection of how the business will perform for the year.
2. How did last year stack up against expectations?
This is a perfect time to look at last year's performance and assess how well the business performed against beginning year expectations. Did you achieve all of the goals and objectives which you set out for yourself at the beginning of the year?
If the answer is "YES", then pat yourself on the back and treat yourself and your loved ones to a little celebration. If, on the other hand, your answer is "NO", then try and determine what impeded you from making these goals. Will these same factors have an impact next year?
3. Were there any big surprises? If so, was it a one-time disruption, or has the underlying fundamentals of your business changed?
Did anything happen last year that threw you off course - either positively or negatively? And, if so, do you expect the impact to be long-lasting?
For instance, was your business negatively impacted by road construction which just happened to occur right in front of your retail shop? Or, perhaps your business did better than expected because good weather drew customers to your outdoor café. In both cases you would expect business to return to normal levels once the construction is complete and/or the weather returns to normal.
However, the set-back (or benefit) may be longer lasting - such as a downturn in the economy, a competing business set up shop next door, or your main product line became obsolete. Or, perhaps your biggest competitor went out of business or your green products are now tax subsidized. Whether positive or negative, these factors may fundamentally change the prospects of your business, at least for the mid-term.
4. What modifications will you make in the coming year?
Assuming the year didn't go exactly as planned (and they never do), then you might want to consider modifications to your business to compensate for these changes.
For instance, increased advertising and signage may mitigate the impact of the road construction. Cutting costs is always a good idea in times of an economic downturn. If the changing dynamics are longer-lasting, then perhaps it is time to pull out your business plan and reassess the market and competitive environment.
5. What are your revenue goals and how are you going to meet them? What additional costs will it take to meet your goals?
If your market dynamics are unchanged and you are satisfied with your revenue levels, then expenses levels will most likely stay the same in the coming year (assuming you watch and manage your costs). If, on the other hand, you want to grow your business (and who doesn't?), then you need to determine how increased revenues are going to be achieved and at what additional cost.
For instance, perhaps you plan to increase sales by introducing a new product line. What are the incremental costs for these goods? Will you be adding salespeople? If so, how much incremental revenue do you expect them to generate and at what cost? Do you expect your existing staff to be more productive? If so, have you given them the proper tools and incentives? Perhaps you plan to expand geographically or with additional space.
All of these items have a cost. Some expenses are relatively easy to dial down (contract labor, moderate levels of inventory, etc.) if the incremental revenue does not materialize within a reasonable timeframe. Other expenses are not as easily adjusted (additional staff, new lease, etc.). It is best to have an idea of expected revenue from the increased costs and a plan to reduce related expenses if the income is not realized within an acceptable timeframe.
6. Do you anticipate any capital expenditures?
Similarly, you need to plan for any anticipated capital expenditures. Perhaps some of your equipment needs to be replaced or upgraded. Or, you need a vehicle for the new route you are planning. Will the purchase be funded through a line of credit, loan, or working capital? In any case, how will it affect cash flow and depreciation?
7. What level of detail is right for your budget?
Budgeting and business planning can be as detailed as you want or need it to be. If you are a hands-on manager and your business does not have much opportunity for improvement or expansion, then you can probably live with less detail. However, if you are watching costs (and who isn't?) and/or are making changes to your business, then you will want more detail in order to track progress against target(s).
At a minimum, you will want to understand and track your key drivers of profitability. In many businesses this is revenue (or course), costs of goods sold and payroll. It would behoove you to have a good system in place to monitor these line items routinely. Whatever the level of detail, make sure it works for you and remember "garbage in, garbage out". So make it quality data and at a level of detail you are willing to work with.
Most business owners track expenses as a % of sales. This is a good indicator of whether you are achieving the margins - and profitability - you expect from your business. If your business continues to run at acceptable margins, then perhaps less detail is required.
Your budget can be very powerful, both in managing expenses as well as in planning and forecasting business performance. The budgeting process is a great opportunity to reassess your current operations and market environment. In preparing your budget, you should understand your planning objectives as well as your commitment to ongoing budget reviews and updates prior to committing to a budget structure and process. And, whatever your objectives, your budget should be a living document. It should not be put on the shelf, only revisited 12 months hence.