|Read more about this book|
(For more resources on on this subject, see here.)
There are two main reasons why you may want to create budgets. You want a trip planner for your business. You will use this on a day-to-day basis to run your business and make decisions. The second reason is if you are seeking outside finance for your business from a bank, investor, or other lender. They will require you to submit your business plan along with projected financials.
Time for action – creating a budget for your business
You are going to create a budget for the next three months to serve as a guide for your operations. Typically, investors, banks and other lenders will need financial projections for a longer period. As a minimum they will need one year projections which may go up to 3 to 5 years in many cases.
- From the menu select Actions Budget | New Budget|. A new budget screen will open.
- Click on the Options toolbar button. The Budget Options dialog will open. For this tutorial, we are going to select a beginning date of three months back. This is only for the purposes of this tutorial and will allow us to quickly run Budget vs. Actual reports.
- In the Budget Period pane, change the beginning on date to a date three months ago. Change the Number of Periods to 3. Type in the Budget Name MACS Jun-Aug Budget as shown in the following screenshot and click on OK.
- The budget screen will show a list of accounts with a column for each month. The date shown in the title of each column is the beginning of that budget period.
- Now enter the budget values by simply clicking on the cell and entering the amount as shown in the following screenshot.
Using the Tab key while entering budget amounts
Don't use the Tab key. The value entered in the previous field seems to vanish into thin air if you use the Tab key. Instead use the Enter key and the mouse.
- When you are done entering all the values, don't forget to save changes.
- Now that the budget has been created, you are ready to run the reports. From the menu select Reports Budget | Budget Report|.
- In the Options dialog select all the Income and Expenses accounts in the Accounts tab. Check Show Difference in the Display tab and click on OK to see the report as shown in the following screenshot:
We are going to create the Cash Flow Budget in a spreadsheet. Go ahead and copy the data from the preceding report to the spreadsheet of your choice. Put in additional rows and formulas along the lines shown below. We are showing the cashflow for a six month period in the following screenshot to make it easier for you to see some of the trends and business challenges more clearly:
What just happened?
What if you had tomorrow's news... TODAY? His name is Gary Hobson. He gets tomorrow's newspaper today. He doesn't know how. He doesn't know why. All he knows is when the early edition hits his doorstep, he has twenty-four hours to set things right. You may recall that in the TV series early edition, Kyle Chandler who plays the role of Gary Hobson uses this knowledge to prevent terrible events each day.
What if we told you that you can get tomorrow's news for your business today? You can prevent terrible events from happening to your business. You can get tomorrow's sales, expenses, and cash flow in the form of a budget. Mistakes are far less costly when made on paper than with actual dollars.
Sometimes budgets are referred to as projections. For example, banks, investors, and lenders will ask for a business plan with profit and loss, balance sheet, and cash flow projections. Other times, these are called forecasts, especially when referring to sales forecasts. Regardless of whether we call them budgets, projections or forecasts, we are referring to the future. Unlike the rest of bookkeeping, which is concerned with the past, budgeting is one area, which tries to look in the crystal ball, and attempts to see what the future might look like, or what you are committing to make it look like.
If you are running a business without a budget, I am sure there are times when the thought flashes through your mind, "I wish I had known that earlier." Your budget is the crystal ball that enables you to see the future, and do something about it. Generally, when you complete a budget, you will have a number of revelations. For example, you might find that your cash flow is going into negative territory in the third month. The budget allows you to perceive problems before they occur and alter your plans to prevent those problems.
|Read more about this book|
(For more resources on on this subject, see here.)
Start with just three budgets
While there are many different budgets you can create, we recommend just three to serve as your Trip Planner – a sales forecast, an expense budget, and a cash flow projection that are detailed in the following sections. Of these, you can do your sales forecast and expense budget in GnuCash. However, for the cash flow projection, you will start in GnuCash but export it to a spreadsheet and refine it there.
Sales are the cornerstone of a budget. It is crucial to estimate anticipated sales as accurately as possible. Base estimates on actual past sales figures. Once you target sales, you can calculate the related expenses necessary to achieve your goals.
Look at what sales you achieved last year, and extrapolate from that. You can add to that based on additional lead generation and sales campaigns that you might have identified. New business owners without this kind of history may try to determine how much business their competitors seem to be able to do, and use that as a guide. Try to make the forecast realistic. If you shoot for an unrealistic target, you can easily spend excessive amounts in promotional expenses and the sales may not materialize.
When you used to pay cash for expenses, life was simple. Perhaps you never did and perhaps you don't agree with me. Put that aside for a moment and stay with me here. It was easy to know when you were running out of money to spend. The wad of currency in your wallet got thin and eventually it ran out altogether. This is the age of plastic. With automatic debits, recurring payments, and electronic bill pay, you could easily be spending money you don't have. That seemed to ring a bell? Great! Now that I have your undivided attention, let us go ahead and review the expense budget that we created earlier.
Don't forget to add the cost of lead generation and the sales campaign costs that were assumed while creating the sales forecast. Also, you might want to provide for an estimated percentage overall inflation rate for the year.
Cash flow projection
With the same sales forecast and the same expense budget, you can go from a comfortable cash position at one end of the spectrum to going bankrupt at the other end of the spectrum. Let us say, for example, that your sales team is able to exceed their quota by extending 90 days credit. However, you are not able to get more than 15 days credit from your key vendors. This means you will have to find enough cash to cover about 75 days worth of A/R. This is the reason why the author of the web article we quoted earlier was skeptical of the fact that selling enough widgets is a substitute for a budget.
In the preceding example, the cash situation is so obvious that you don't need a cash flow projection to know that you are going to fall short. However, in other situations it may not be so obvious that you are going to fall short. For example, if you are offering a variety of credit terms to different customers and different products. Also, in addition to sales and expenses you will have to take into account other cash flow items such as loan repayments, owner's draw, and so on. Even more importantly, it may not be obvious what actions need to be taken to improve the cash flow. In short, you need a cash flow projection.
We recommend that you create the sales forecast and expenses budgets in GnuCash, create a report, and paste it into a spreadsheet such as OpenOffice Calc or MS Excel for creating your cash flow projection. There are several advantages to doing this in a spreadsheet:
- You can rearrange the rows, to your convenience, like we did in the tutorial earlier.
- You can put in formulas.
- You can do what-if analysis or simulation by making copies of this spreadsheet.
You might ask, "Why at all create my budgets in GnuCash, if I am going to export it into a spreadsheet anyway." The main advantages to creating the budget in GnuCash are the ability to estimate based on past period actuals and the ability to create the budget vs. actual reports. The Diff column in the report helps you to focus on the few accounts requiring your attention, when you have a large number of accounts.
You can take cash flow management steps to ensure that the gaps are closed, or at least narrowed, when they are predicted early. These steps might include lowering your investment in accounts receivable or inventory, or looking to outside sources of cash, such as a short-term loan, to fill the cash flow gaps.
Estimating based on previous period actuals
If you have past transactions recorded in GnuCash, the easy way to create your first draft is to let GnuCash estimate the budget values by looking at those transactions. First, open a budget or create a new one. Select one of the accounts for which you want GnuCash to estimate. Then click on the Estimate toolbar button. In the Estimate Budget Values dialog, select the Start Date. GnuCash will start at that date and look forward for the duration of your budget. For example, if you are making an annual budget, and you select Jan. 1, 2010 as the Start Date, GnuCash will look at all the transactions in that account from Jan. 1, 2010 through Dec. 31, 2010. Here is a screenshot:
There is no specific way to select multiple accounts for doing this estimation. You have to select one account at a time and create the estimates.
Financial projections for investors and lenders
As part of a business plan, a budget can help convince a loan officer that you know your business and have anticipated its needs.
In addition to the three budgets that you created for your own internal control needs, investors and lenders might ask for two more budgets, namely the Balance Sheet and the Income Statement (also known as the Profit & Loss statement or P&L). GnuCash has built-in reports for these two. Therefore, you can generate these two reports from an existing budget.
How to create a business plan?
Once you have created your budgets, you have the data required to create a Business Plan. You can consider free business plan templates with instructions available from SCORE (www.score.org). SCORE is a resource partner with the U.S. Small Business Administration (SBA).
Budget balance sheet
The first one is the projected balance sheet:
- From the menu select Reports Budget | Budget Balance Sheet|.
- Click on the Options toolbar button.
- In the Display tab, uncheck Include accounts with zero total balances and check Omit zero balance figures. This will make sure that zero balance accounts and figures are suppressed so that you won't be distracted by those.
- In the General tab uncheck Single Column Balance Sheet. This will create the balance sheet in the traditional two column format with Assets in one column and Liabilities in another column.
- In the same General tab make sure the budget you earlier created is shown selected in the Budget dropdown list. If not, select it. Click on OK.
You should see a two-column balance sheet with the Total Assets on the left-hand side and the Total Liabilities & Equity on the right-hand side, nicely balanced.
Budget income statement
The other report that investors, banks, and other lenders ask for is a projected income statement also known as the Profit & Loss (P&L) Statement.
- From the menu select, Reports Budget | Budget Income Statement|.
- Click on the Options toolbar button.
- In the Display tab, uncheck Include accounts with zero total balances and check Omit zero balance figures.
- In the General tab make sure the budget you earlier created is shown selected in the Budget dropdown list. If not, select it. Click on OK.
You should see the projected income statement with Total Revenue on top, Total Expenses at the bottom, and the net income for the selected period below that. The Budget Profit & Loss report creates the same report.
Remember that a budget is a living document. Market conditions may change, you might land some unexpected new customers, or you may develop a new product or service that becomes a hit. Don't abandon your budget and start shooting from the hip. Revise your budget, and stick to the new budget you've developed. It is not prudent (that word again!) to keep revising your budget for every little change. Typically, you need to consider a budget revision, under the following conditions:
- There has been a drastic change in the direction of the business as a result of any of the reasons that we outlined previously.
- In the case of an annual budget, if there have been a number of small changes, many business people find it convenient to make a mid-year budget revision.
In this article we noted that budgets are called forecasts or projections at times. We looked at why budgets are needed, how to create them, and how to create reports showing budget vs. actual comparison.
In the next article we will take a look at employees and payroll, depreciation, and owner's drawing.
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