The Point of Budgeting In Small Business

Too many small businesses operate without budgets. And many small businesses that do have budgets aren’t getting as much out of them as they could. We’ve seen it time and again.

It isn’t because the mechanics are difficult to manage. Everyone knows the basics of how budgets work: you track money coming in, you track money going out, and you do your best to plan for the future. In fact, the very simplicity of that formula is what leads some small-business owners to consider budgets not worth the trouble.

Therefore, what we’ll discuss here isn’t what budgeting entails, because if you don’t already know that, you can find it out with ease. We’re more interested in why you should budget in the first place. Our suggestion, to put it plainly, is that budgeting is a way to amplify the very creativity and adaptability that allow small businesses to thrive.

Budgets’ Reputation

You don’t become an entrepreneur because you have a burning love of spreadsheets. At least, not usually. Being an entrepreneur isn’t supposed to be about budgeting. It isn’t supposed to be about paging through endless columns of variable costs or putting caps on spending. It’s supposed to be about having the freedom to blend innovation and risk-taking with passion and expertise. It’s supposed to be about removing barriers, not building them.

That being the case, small-business owners often see budgets as antithetical to the very spirit of entrepreneurship. According to this perspective, budgets impose stifling limitations. They’re artifacts of mega-corporate culture devised by clammy-handed people in windowless rooms with poor lighting. They may be necessary evils for sprawling, inhuman conglomerates, but when it comes to organizations that rely on individual personalities and individual decision-making, budgets are more burdensome than helpful.

You might say the constraints imposed by budgeting make small businesses less nimble. Since nimbleness is one of their main advantages over larger rivals, budgets actually decrease small businesses’ ability to compete.

Or so the story goes.

Some of it is accurate. For instance, it’s true that passion and innovation go hand in hand with entrepreneurship. It’s true that small businesses should strive to leverage their size into a competitive advantage. And it’s true that budgeting for small businesses is much different from budgeting for colossal corporations.

What’s not true is that budgets impose constraints. Budgets don’t actually impose anything. They merely describe constraints that are already present. Perhaps more importantly, they describe a business’s ability to cope with and even manipulate constraints placed on it by forces internal and external.

Constraints and Entrepreneurial Creativity

If you’re an entrepreneur, you’re aware that your business doesn’t operate in a vacuum. It’s part of a staggeringly complex system. For instance, you have your relatively immediate concerns, such as your employees and your local government. You also have your relatively big-picture concerns, such as national debt and foreign trade policy. No matter what, when you start a small business you’re going to be hemmed in by laws, regulations, and unavoidable economic realities, all of which will have a major impact on how you operate.

In other words, no small business starts out in a position of unfettered freedom. The very conditions that allow small businesses to exist also impose a variety of constraints. Working capital, interest rates, the minimum wage, the minimum competitive salary for professional employees-there are countless factors that limit what you can do and how much money it takes to do it.

You can acknowledge the reality of these factors, but if you don’t have a budget, then you might not know the exact ways they’re affecting you. What particular constraints does a business in your industry have to deal with? Are there some that have a disproportionate impact on you because of the way your business functions? Can you make changes to reduce their impact? Are there constraints that you handle in an especially productive way? Can you turn this productivity into an advantage over your competitors? Do you approach some constraints the way everyone else does, even though you could be doing a better job with them?

These are the sort of questions a budget helps you answer. It doesn’t create limitations that weren’t there before. Rather, it gives you a way to assess the pre-existing limitations that every small business in your industry has to deal with. The more thorough your assessment of those limitations, the greater your ability to work within them, work around them, or in some cases, make them work for you.

Making limitations work for you is where entrepreneurial creativity comes into play. If you have enough details on your business’s limitations, then you’ll be better able to turn those limitations into innovations. A budget will help you marshal your creative energies and find the opportunities for profit embedded in the market’s constraints. It tells you exactly what assets you have to work with, and helps you map out how those assets can be put to the most productive use given the rules of the industry.

After all, most of the market-based constraints you experience will be shared by your competitors, who also have limited amounts of money and freedom. Which of you comes out on top won’t be determined by who has the fewest constraints, but by who does the best job of manipulating common constraints to find the possibilities they hide.

Speed, Spontaneity, and Profit

Small businesses, precisely because they’re small, tend to be better than their larger competitors at taking quick, decisive action. It’s one of their vital advantages. By the same token, it’s one of the challenges that all entrepreneurs are bound to face. You’ll be forced to react on a moment’s notice to emerging opportunities or perils in the market-that’s a given.

What’s less certain is the profitability of your reactions. Obviously, acting or adapting fast doesn’t do much good if it yields a loss.

So what information will you use to make your quick decisions? Do you have a detailed, practical breakdown of your business’s strengths and weaknesses? Do you know exactly how many resources you can afford to redeploy at a moment’s notice? Do you know how efficiently different aspects of your business tend to use the resources you devote to them? Are certain aspects of your business already strained? Are certain aspects flush with the potential for expansion?

A budget gives you a diagnostic readout of your organization. It tells you how much stress the business can handle and which areas can handle it. Hence, it helps you decide whether acting conservatively or aggressively in the short term will enhance your performance over the long term. Without a budget, you’ll be relying too much on guesswork, and many of your quick decisions may be needlessly risky.

Supply-chain Relationships

A budget not only helps you assess yourself, but also helps you assess your relationships with other entities, like vendors and subcontractors. This will be especially important when the market is in flux.

As you know, successful entrepreneurship entails evaluating the vast array of forces that constitutes the market and determining where-for someone in your industry, someone with your passion and expertise-the opportunities and roadblocks lie. But no one can predict with any certainty how the market will behave tomorrow. There will be surprises. Sudden chances and sudden setbacks.

We’ve already noted that the way you respond to these inevitable surprises will play a critical role in the profitability-or survival-of your business, and that your ability to make the right call at the right time will be drastically greater if you have a budget in place. This is not only because a budget tells you about your own resources, but also because a budget helps you deal with other organizations that affect you.

Let’s say you experience a sharp increase in demand for your product. It’s good news, but it brings up questions: Do you have enough working capital to provide your product to a large number of new customers/clients? What are the current resources of each division of your business? How many more resources does each division need if it’s going to ramp up its activities? How efficiently does each division tend to use its resources?

These are all internal questions that may well lead to others, such as: What do your vendor accounts look like? How much new inventory can you afford to purchase? What type of sales will you need if you’re going to pay off the new purchases on time? Can you afford to hire subcontractors to help with the push?

And, of equal or greater importance: What’s your plan for a downturn in demand? Will you find yourself in a precarious position with your vendors? Will you be able to keep promises to new customers? Will you be able to pay your subcontractors for the hours they’ve put in?

Indeed, budgeting can provide invaluable support for all your relationships. As noted on Inc.com, “your suppliers are in all likelihood mapping out their expectations for the year and you can help them do so by providing your outlook. As a best practice, you should share your budget and the variety of scenarios you might face to see whether they can handle each level of demand” (Field 2010).

Since your business is one element in a network of other businesses, it’s important for you to be able to communicate both your capacities and your expectations to the people you rely on. A budget serves as a tool for facilitating such communication. It gives you a concrete way of describing not only where you stand, but also where you will stand in a given scenario. Thus, it helps foster strong partnerships and avoid uncomfortable conversations.

This doesn’t mean sharing every detail of your budget, nor does it mean sharing some details with everyone. It simply means that guarding your budget like a state secret takes away some of its efficacy. You can use select portions of your budget to assist you in negotiating with critical partners-i.e., you can be prudent about the information you divulge without being obscure. How much do your current business partners know about your budget? Is it enough for them to understand your capacities and your needs?

The Bank

Speaking of business relationships: you don’t want to mess around with the bank. Plain and simple. This is a relationship that should be as friendly and open as possible. And what do bankers like? Budgets. As the American Bankers Association (ABA) says, “You are flying in the dark financially if you don’t have a budget for all income and expenses.”

Come to them without a budget, and bankers are going to feel like you’re wasting their time. They’re certainly not going to be interested in loaning you money (or more money). “Prepare for your financial review with your banker,” says ABA. “Have current inventories, cash flows and balance sheets ready.”

When your banker asks you how your debt is structured, and whether you have an imbalance between long- and short-term debt, what are you going answer? Trust us: if you show up to that meeting with a budget, you’ll be glad you did.

Flexibility

Just as the market’s unpredictability makes budgets useful, it also makes them fallible. A budget is like any plan: it will contain inaccurate predictions and require ongoing revision. That’s simply a condition of commerce; some academic models are predicated on entrepreneurs having perfect foresight, but we all know that’s not the case. Businesspeople, even the world’s most celebrated financial prognosticators, get it wrong sometimes.

That doesn’t render planning completely useless. Even if your plans don’t entirely match the way reality unfolds, they serve as benchmarks against which you can assess your progress. They record where you wanted to go, where you actually went, and why the two didn’t coincide. In that way, they indicate which areas of your business are performing well, and which need to be modified in order to meet next quarter’s goals.

When it comes to small-business planning, certainty is off the table. Nothing is guaranteed, including budgets. But setting expectations and monitoring progress remain indispensable to long-term survival. They help small-business owners analyze why they’re drifting off course, and also help them formulate corrective measures.

How do you see a budget? As a static report that turns old news into flimsy predictions? Or as a series of living documents that records how you adapt to change?

Personnel

Thorough budgeting calls for a great deal of effort, and many small-business owners can’t spare the necessary time or energy. Frankly, while the minutiae of budgeting are of interest to the entrepreneur, they are not the entrepreneur’s main job. If they were, then a good head for numbers and a background in financial analysis would be prerequisites for entre

Posted in Uncategorized | Comments Off

Starting Up a Small Business Concerns

Volatility

In a previous article I dug a bit deeper into small business volatility but it is worth mentioning again especially in the context of getting a business started. Small business exists because large business has carved out a method to meeting the needs that doesn’t reach everyone in a market place. In other words small business is small business because large business has deemed the pursuit of such market places not worth the effort. Large businesses seek opportunities that exist in well-established mature markets. These would be markets that yield smaller margins but are also less volatile. Consequently this leaves the more dynamic and volatile markets for the small businesses. This is part of why small businesses don’t last long, they compete in an ever changing market place.

So, what does this mean for you? It means that the opportunities that will exist for you and the business you aspire to open will be opportunities that require quality and custom solutions quickly. This also means there will be a good deal of work involved in order to gain market share for you niche. Abandon any idea of providing a single product or service, you will need to diversify your products/service, customers, and possibly industries. To combat the ebb and flow of the small market place you will need diversify all aspects of your company.

Alignment

Ok, now that you understand a little about the realities of the small business market place the next thing to look into is how well your potential business aligns with who you are. In the beginning stages of a business the founder is the business and the business is the founder. To offer the most value the business should be the embodiment of you and you should be the embodiment of the business. The realization of a single opportunity should not be the only deciding metric for starting a business. As an example; A few years ago I had the opportunity to start a frozen yogurt shop in my town that would have been modeled after a profitable model that was doing well in other cities. I did my homework and found that for $40,000.00 I could have everything I needed to open the doors and start selling yogurt. I decided against it for two reasons, 1. I live in a four season’s area and I did not want to have a feast or famine demand and 2. I am not that crazy about yogurt. Now, the opportunity was there, and since then many of these shops have opened, but I didn’t want to invest 80 hours a week into a frozen yogurt business.

Market Positioning

So you have an idea that aligns with who you are, and you have come to understand the nature of the small business market place, how are you going to position your product or service? How are you going to meet the needs of the customer? The answer is somewhat laid out above, but because of the nature of the small business market place you will need to become a high quality, quick turnaround company. Small businesses have the advantage in small volume custom areas. Your competitive advantage will be your ability to cater to the specific needs of your customer. As a small business you have no business competing on price.

Margin

You are your business, and chances are you do not have much capital behind you. This means that achieving a positive cash flow situation as quickly as possible is key. Cash is king and without it you don’t have a business. The upside is small volume high quality work demands top dollar. That’s right, by being a small business you are competing in a large margin arena. The mark up on your products and services can and should be high. The market will let you know when you are too far out of range, but a healthy profit margin is to be expected with small businesses. Individuals that fail to understand this begin to lower their prices in hopes of gaining some sales but what they don’t realize is they are diluting the market and putting themselves out of business. So, don’t be afraid to charge for your work!

Growth Strategy

The last thing I will mention for those looking to start a small business is that a growth strategy is imperative. You need to have an idea of where you are going if you ever expect to make it as a business owner. By nature small businesses should only remain small for a while, if you company is not growing it is dying. Markets mature, customer needs mature, and guess what… your business should also be maturing. Knowing where your business is headed will allow you to take the appropriate measures today to set up for tomorrow’s market. A growth strategy can be vague. You don’t need to define every variable, but you should use your intuition to determine where you should position your company.

If you are planning on starting a small business understand it is a lot of hard work and there are no rules. There is no one telling you what to and not to do, you will be responsible for your success or your failure. You must be persistent and willing to invest more of yourself than the next guy in line. If it were easy everyone would do it, but because it is demanding there are only a few to compete with.

T.J. Mollahan

Posted in Uncategorized | Comments Off