Too often the annual budget is simply reduced to “how much money is/should our business be making” and “how can we reduce costs over the coming twelve months”. In reality, it should be the equivalent of an annual health check for the business as a whole.
Establishing financial targets is all and well and good, but it is a futile exercise if not allied to a wider assessment of your business. At Christopher Ward we view the annual budget as an opportunity to review and recalibrate the business, rather than just a dry, financial process.
Essentially the budget is an opportunity to take a step back from the coalface and look at the broader picture of where the company has been in the preceding months and years, and where it should be heading.
Nevertheless, there are five key financial components to every annual budget: sales, margin, stock, cost and cash – and to help everyone remember them we talk in terms of the acronym, SMSCC.
Forecasting sales a year ahead, especially by week (as we need to do in a retail business) can be a frustrating business. But the level of accuracy achieved is often an interesting insight into how well the team understands a business. Accuracy of sales forecasting is, therefore, a useful KPI for those responsible.
Of course, there are any number of variables to consider from micro business issues all the way to macro-economic ones (Brexit, anyone?). But the fundamental start point is a thorough understanding of the previous year’s performance before overlaying with the “known knowns” of the year ahead.
Understanding where the level of granularity sensibly ends is also important as the more detailed the level of forecasting the more inaccurate a budget is likely to be.
You’ll be budgeting at both the gross and net margin levels. In my view, you should always be pushing to increase your gross margin levels. Not only does this force creativity in the negotiation of cost prices with your suppliers, keeping them on their toes, but it also provides insurance should the year not quite turn out as planned and you end up having to take more discounts than originally envisaged.
Stock is evil
I have always subscribed to the Japanese view that “stock is evil”, and that higher than necessary working capital levels divert hard-earned cash away from growth-delivering activities, like advertising.
Back in the early 1990s I was the buying and merchandising Director for BHS, and introduced average stock holding levels as an ingredient into a buyer and merchandisers performance KPI criteria. Previously they had only been judged against sales and margin, but we introduced the calculation of gross margin return on investment (GMROI) as below:
Sales x gross margin ÷ by average annual stock on hand
It not only helped the teams understand better the real consequences of their actions, it helped to reduce discounting by more than half the previous levels (the real cost of high levels of stock for a retailer) resulting in the business achieving record profitability levels.
Costs – analysis or paralysis?
Cost budgets are the easiest to control and sometimes it is easy to become “penny-wise and pound-foolish”. By keeping such a tight control of costs growth is constricted.
Having said that, one of the toughest strategic decisions most growing small companies have to make is should the business invest ahead of growth or wait until the pips are really squeaking before putting in required infrastructure. Depending on circumstances, both approaches have validity.
People costs are often the biggest line any annual budget, with salaries being the biggest element. Rewarding your best people appropriately is key to keeping them motivated whilst carrying the wrong people is likely the biggest hidden cost a business has. The annual budget is, of course, a good time to address both.
Cash is king
No business went under because they made a loss, each went bust because the company ran out of cash. Whatever you decide in your annual budget, it needs to be modelled in a cash-flow to make sure its affordable. Sounds obvious, I know, but I have often been astonished how many companies don’t link plans to cash – and some paid the ultimate cost.
At the end of the annual budgeting process you will have a profit target figure you will be living with for the next 12 months. I always have a profit figure in mind that I want the business to achieve from the outset of the process rather than allowing the sum of the parts to add up to a figure. This puts everyone on notice about the direction of travel you are wanting the business to go in and should be challenging enough to push thinking but realistic enough to feel achievable.
The key, once the annual budget is published, is to regularly measure your performance against it. Of course, every budget is wrong and the real measure of a successful business is how well it manages to build on the positives and minimise any negative as the year unfolds – unless if course you have managed to get those customers of yours to buy to budget!