Hopefully by now the year’s budget was completed months ago and tracking results against it is ongoing. Unfortunately, for many businesses, once complete, a budget finds its way into a drawer to not be seen again until it’s time for a new one the following year. As one of the many Budgeting Best Practices we recommend, a deep budget review at end of each quarter end can illuminate key learnings and present an opportunity to revisit assumptions. Let’s discuss what you can learn and what to do from here.
How Good is Your Process?
This quarterly review is an opportunity to assess the quality of the budget process itself. If you are already significantly above or below budget in key areas, that calls into question the validity of the assumptions, the rigor of the process or worst of all, material execution misses. This might invite a rethinking of planning going forward and can influence future decisions.
Don’t Keep the Budget Open
Some companies don’t finalize a budget until well into the new year, waiting to get the most accurate assumptions or seeking more information. A budget process should be thorough, but equally important is having a budget in circulation. It is way too hard to draw a line on when the information is finally “good enough” if there is not a time deadline along with the budget. Perfection in a budget does not exist, planting a flag in the ground to serve as a true north is key.
Budget vs Forecast
While a budget can be viewed as a type of forecast, it is almost always an annual process that leads to a comprehensive operating output. We are strong advocates of forecasting and reforesting throughout the year. Every quarter is a great routine cadence that can be helpful for management planning, external uses like updating lenders or investors and evaluating what-if scenarios as new opportunities arise. Some specific examples include:
This forecasting can be essential to provide confidence for management as well as external stakeholders as business evolves during the year.
Maintain Integrity of the Original Budget
Don’t change the budget! Of course, there can be exceptions like a major error or calculation of a line item, but this is a very slippery slope. Once a precedent is set, it is way too easy psychologically to manipulate numbers. Constantly moving goalposts makes management ineffective. While a company may argue we should adjust the budget because sales are already 25% ahead, what if the flipside were true? If the company is underperforming and the budget is lowered, all that has done is changed expectations and condoned poorer performance.
A budget is a critical planning and operational tool for any business. Regular forecasting is an equally important and complimentary tool. Both allow management to be better students of the business, improve operational performance and navigate the challenges and opportunities that arise over time.
Two seconds on social media or the television is enough to find heart wrenching images of the assault of democracy in the Ukraine. Our prayers are with the families and freedom fighters that are standing up to violent aggression in their homeland. This is a human story, but also has economic consequences for business owners to carefully pay attention to.
Yes, the stock market has been fluctuating wildly. That is one noticeable economic barometer. What underlies this is the potential of growing headwinds to the economy and its small businesses. Oil prices have skyrocketed, meaning we all pay more at the pump. But oil is involved in so much more than just fueling our cars. Air travel could get more expensive, and the cost of shipping goods, which has already dramatically gone up in the last months, could increase even further. Oil is also a key ingredient in so many products from plastics to packaging. It almost surely has a bearing on the products you sell. Rising wages may not slow either. Utility costs and commodity prices will also be impacted. And as this all compounds the inflation problem.
There has also been talks of additional sanctions. Because of how the global economy is so coupled together, these sanctions could have a double edge sword. Their impact on Europe in particular, which depends on Russia for a significant amount of oil and gas, could cascade indirectly to the United States, creating even more disruption.
So as a business owner, what do you do?
1. First, understand the potential risks to your business. Pay close attention to current events and their byproducts, including the price of oil. New sources cannot be started up overnight, and of course large suppliers like Saudi Arabia could pump more oil into the system thereby lowering oil prices. But in the short term, the oil markets will be disruptive. The volatility of oil prices has long been a proverbial canary in the coal mine, so as this continues, business owners should be on high alert.
2. These are uncertain times, there is no reason to anticipate long term headwinds, but it may make sense to re-assess certain initiatives or growth plans short term. Perhaps even just a pause or tempering of expectations is warranted. This is unique to each business, but all businesses should at least be asking questions internally on any potential negative impacts.
3. Don’t operate out of fear. Some businesses owners are just exhausted and even paralyzed after battling Covid, inflation, and now the effect of a war oversees. Educated, thoughtful action is critical. The American entrepreneur has survived recessions, the Cold War, and commodity crises to name a few. Stay strong and re-assure your teams.
These are sad, troubling times without question. We must never forget - democracy will win, capitalism will win, and small business will win. You are the driver of the American dream that countries like Ukraine are fighting so hard to model after.
We hear from business owners constantly that they are making profits, but don’t have a lot of cash at the end of the year to show for it. One big reason is that they are constantly investing in their businesses. This concept of “reinvesting” profits frequently occurs, especially in growing businesses where the expected payoff is down the road. What often gets overlooked however is the importance of where, why, and how that investment is occurring. And the answers can be key to accelerating growth and managing cash and the business overall.
Why does this matter?
A key word we stress is intentionality in actions and choices within a business – in simple terms, telling money where to go. And, next, what should that investment result in? Sometimes the investment is long term in nature, meaning the ROI will be long term as well, but it can also be short term. Sometimes an investment feels like a simple cost of doing business, for example hiring a new team member, such as an inventory manager. However, that role should improve control over inventory, meaning a reduction in potential losses or inventory shrink. It may be indirect, but there is still an ROI on that investment. Business owners need to understand where they are investing in the business, and what they expect to generate as a result.
The ability to go back and revisit what actually happens relative to what was expected is an essential learning tool for further decision making. This is also critical in evaluating options. Small businesses operate with limited resources, and are all about choices, sometimes tough ones. So let’s look at some key areas where investment occurs:
CapEx – An obvious area of investment is capital expenditures. This could be new equipment or an upgrade to equipment, IT, real estate or vehicles. This won’t show up in the P&L directly. So how can you clearly bucket and track these investments over time? And before an investment is made, what is the business case? Is that a better use of funds than others?
People – People are a huge area of investment in businesses. This could be adding a key executive or operating role to allow for better efficiency or scale. It could be in accounting to handle additional sales volume. Maybe it is time to add a role in house, such as HR. These are all areas of investment in the business. The organization of tomorrow has to be built, and that building means investment. And whether direct or indirect, how do these investments impact profits, risk and asset growth?
Marketing – Marketing comes in many shapes and sizes, so a distinction here is key between ongoing and an investment. Marketing such as Google Ad spends are clearly ordinary course of business expenses, however, perhaps the business is exploring a new initiative such as building out a email marketing system, maybe there is a sizable upfront spend in imagery and physical materials, or even engaging an outside PR firm. There is an investment involved here for a longer term payoff.
Inventory – Many businesses in growth mode make investments in inventory. This could take the shape of a decision to carry larger amounts of in stock inventory to meet growth, or perhaps a buildup of inventory in a new product. This is a key use of cash that should have a tangible ROI. And while this will likely become the new norm, that initial buildup is an investment, and should be viewed that way.
Systems – Systems can take a lot of shapes and sizes. This could be a new cloud-based software platform. It could be more rigorous processes, such as a new manufacturing line configuration or the material addition of checks and balances. That spend is an investment. And while some will generate profitability and efficiency, they often reduce risk, protecting future profitability and assets. What capital needs to go to developing or upgrading systems?
Expansion – Some businesses choose to expand, whether geographically, horizontally, vertically or just by product or service offering. This category can be a catchall for multiple of the categories above like people and systems in addition to start up costs such as legal, compliance and testing.
The keys are to identify where money is going, track it over time and view the overall business to understand investment versus normal operations. Ask the questions, understand where things are headed and make educated decisions and evaluations. Years of high investment will often show lower cash balances and often lower profits as well to be followed up by higher profits in future years as the ROI is realized. Without a thought process around investment, how do you know if an investment is working? Should you do more or less? Can you tell the difference in your business? You want to.
Many companies find themselves with unexpected amounts of cash on hand as a result of PPP funds, stronger financial results and reduced spending over the last 12-18 months. While on the surface, that is an enviable position, many CEOs are struggling with the best decisions related to that cash, especially as there is still so much uncertainty in the global economy. It is highly likely there is no one right answer, but a combination that will strength the overall health of the business and its owners.
Here are a number of options to consider.
1. First and most importantly, understand any large pending uses of cash, the most obvious of which is taxes. Businesses that performed better than expected are likely to have higher tax liability as a result. What is the cash balance after that tax liability is paid? That number becomes the starting point.
2. Maintain reserves. Every business should have a minimum amount of cash on hand at all times as an internal insurance policy. This amount will vary by business based on the volatility of income, the amount of monthly expenses and how capital intensive the business is, but this should be a well thought out baseline.
3. While interest rates are historically low, there are still options to earn yield on cash balances. Talk to your bank about different programs that may increase returns without taking on unnecessary risk. More so in instances where future uses of the cash are expected, finding ways to earn even a minimal return for a period of time is better than a simple savings account.
4. Invest in the business. Are there options to invest in the business that will generate near term and/or long term returns. Perhaps an investment in new equipment, people, marketing initiatives or expansion opportunities. Key to this is an evaluation of the return, but this may be a time to reinvest in areas to propel further growth.
5. Stock up on inventory. Especially given a strained supply chain, purchasing larger quantities and/or carrying larger inventory balances could be critical to generating the revenue desired in the future. You can’t sell what you don’t have, and some suppliers are lowering per unit pricing for larger orders.
6. Pay down debt. Particularly in the case that reserves are sufficient and there are not areas of good ROI investment in the business, accelerating the payment of debt can make a lot of sense. Interest is a cost to the business even when rates are low. And companies with lower leverage are most often better positioned to take advantage of opportunities down the road because they have a greater margin for error.
7. Reward your people. Success is a team effort and this could be a great opportunity to share the benefits of the success, especially given the tight labor market. Profit sharing and bonuses are great, but there may also be meaningful rewards that cash can buy – experiences, thoughtful gifts or extra benefits and perks throughout the year.
Regardless of the amount of cash in a business, having a plan on where it goes is key, and for every business that plan is unique. Don’t just let cash sit there, take action on where it goes to best support the business and its growth.