Spending money you don't have or budgeting for revenue that never materializes can kill your business. Having a formal budget-setting policy helps you manage your finances. Depending on the size of your company, the policy may be a few simple guidelines or a written budget policies and procedures manual.
Why A Budget-Setting Policy?
It's possible to set your budget without a budget and forecasting policy. Look at your resources, fixed costs and variable costs. Project your future revenue and decide what you need to spend it on.
When you sit down to draw up your budget, though, those decisions can get tough. If your revenue has grown, should you save the extra for emergencies? Buy new equipment? Give the team bonuses? All of the above? By drawing up a budget-setting policy before you start planning, you can clarify your priorities.
Principles and Policies
A good first step to developing a policy is to write down one or two basic guidelines. For example:
- Having a large contingency fund is a top priority.
- It's essential to attract and retain talented employees.
- Delivering quality, defect-free products is vital to your success.
- It's best to keep your own pay low for now so you can grow the company and enjoy a big payoff.
Once you write down your principles, you can turn them into a budget policy.
- Your contingency fund should be large enough to keep the doors open for three months.
- Revenue will be plowed back into research and development until you can guarantee a no-defect product.
- You'll increase your own salary only in proportion to sales revenue growth.
A big part of budgeting is projecting revenue and expenses for the coming quarter, or year or three years. As forecasting involves lots of variables, often leading to multiple possible outcomes, it helps to have a policy about how you'll deal with uncertainty.
Say you're launching a new product line and also slashing prices on your old products. Your revenue projections may vary wildly based on the prices you set, the amount you manufacture and whether the new product is a hit, a flop or a moderate success. With several possible futures, it helps to have a policy for how to evaluate the different forecasts:
- You look at the most likely, most realistic scenario and adopt that.
- You're a risk-taker, so you select the option with the potential best payoff.
- You adopt the forecast with the lowest amount of possible profit. That way you're less likely to anticipate revenue that doesn't materialize.
- You look at the potential losses and pick the path with the smallest risk of loss.
From Policy to Procedures
If you're a one-person business, you don't need a budget policies and procedures manual. As you grow, though, you may have to bring in more employees; if you incorporate, you'll also have a board of directors to answer to. Having a manual that spells out the financial policies and procedures for your small business may start to look like a good idea.
A sample procedure could be:
- Review your strategic plan for the company.
- Set business goals based on the plan.
- Identify your fixed expenses, such as rent, insurance and employee expenses.
- List variable costs, such as overtime.
- Draw up projects that advance your business goals. Identify the costs of the project.
- Set your profit margin.
- Submit the budget to your board or stakeholders for approval. If they have objections, either convince them to support your budget or make the requested changes.
You should also have procedures for a regular budget review to see how close you come to your projections. If, say, there's an emergency requiring a cash fix, you'll have to adjust your budget. If one of your departments is overspending, you may have to rein them in or cut spending somewhere else to balance it out.