Imagine the embarrassment: You’re a business owner, and you’ve just issued a round of payroll checks. Several of your employees have taken their paychecks to deposit over lunch, but they came back with bad news — the checks didn’t clear, because you didn’t have enough money in your bank account to cover them.
It may sound far-fetched, but this scenario plays out all too often. My father told me once that at his first grown-up job, employees would race each other to the bank on payday to make sure that they got their money while there was still money to get. The company he worked for was on such shaky ground that it couldn’t reliably make payroll. Can you imagine how red-faced that boss must have felt?
There are a lot of things that can cause a business to get into that kind of cash-flow trouble. One of the biggest is bad budgeting, or a complete lack of budgeting altogether. We’ve talked before about how budgets are essential to maintaining our personal finances in good order, and the same is true of business finances. In fact, budgets may be even more essential in business. When done right, budgets can be part of your road map to growth and success. When done wrong, they can lead your business down the road to perdition.
As we’ve said before, a budget is a plan that we put together to tell our money what to do. Using budgets, we plan for the amount of money that we plan to take in each month, and decide how all of that money will be allocated. We use budgets to keep track of our expenses, and to tell us how much we can spend on any given item. Budgets help individuals and families to make sure that they have enough money each month to pay the rent, buy the groceries, and keep the lights on, as well as plan for semi-regular or one-time expense.
In theory, business budgets work a lot like personal budgets. You list your expected expenses and expected revenues for a period (a month, a quarter or a year), and then make sure that you’re not spending more than you take in. If you find that you have extra money that isn’t accounted for in your regular expenses, the budget allows you to plan on how you will invest that money back into the business, or how you will use it to pay yourself profit as the business owner.
The nature of business, however, presents some budgeting difficulties that individuals don’t often face. While most individuals can count on being paid the same amount every paycheck, as a business owner, you can never be certain what your revenues will be (especially if you run a seasonal business). And business expenses can change much more quickly than personal expenses — if one of your major vendors raises the price of a key product or service, there’s not much that you can do but absorb that cost.
All this means that business owners need to exercise a lot of caution in planning their corporate budgets. Experts can teach you all kinds of great strategies and techniques for business budgeting, and I would encourage you to learn about those. For right now, though, here are three key pitfalls to avoid in your business budgeting:
1) Over-estimating your income.
We’d like to think that our companies will always be making lots of money, but the fact is that revenues can change at any time, due to circumstances beyond your control. A new competitor, a change in technology or the fickleness of consumer tastes can pull business away from you quickly. If you’ve budgeted for more income than your company will actually earn this year, it’s going to leave you in a lurch. So always be conservative with your business budget. Remember, it’s never a problem if you earn more money than you planned for. But if you plan too optimistically and aggressively, you might find your payroll checks bouncing as well.
2) Under-estimating your expenses.
There are various and sundry expenses associated with running a business. Your facilities (overhead) and payroll are probably your biggest expenses, and they’re also your most predictable. But there will be dozens or hundreds of other little things that come up every year that must be planned for. You’ll have taxes to pay, light bulbs to change, and break-room microwaves to replace. If you’ve only budgeted to cover your predictable monthly expenses, you’re leaving yourself exposed to a lot of annual, semi-regular or downright irregular expenses that come up. So be thorough in your budgeting, and review your spending for the last few years to account for every conceivable expense that could come up. And be sure to allow room for fluctuations in the prices of inventory, raw materials or vendor services.
3) Spending money outside of your budget.
One of the biggest temptations that we face in personal finance is the desire to spend money that hasn’t been budgeted. Sometimes if there’s something I really want, something inside of me says “To heck with it!”. I’m tempted to think that it will all work out in the end. But with that attitude, it rarely does. The same is true in business. Sometimes exciting business opportunities present themselves, and tempt us to spend spontaneously in order to capitalize on a hot new trend or even a legitimately profitable venture. There’s nothing wrong with having financial flexibility — it can allow you to launch a new marketing campaign, hire new employees or penetrate new markets. But flexibility is not an excuse for budget irresponsibility. If you find yourself wanting to make an unplanned purchase, it’s important for you to first go back to your budget and work out a reasonable way to pay for it. If you don’t, you risk under-funding part of your established operation in order to pay for an unproven idea.
If you don’t carefully budget your business’ money, you could find yourself eventually robbing Peter to pay Paul. And if Peter and Paul feel like their paychecks may not clear, they’re both likely to find someplace better to work.
Photo by Clemens V. Vogelsang. Used under Creative Commons License.