As I’ve written before, creating a budget for a business is not hard. What IS hard is, creating a budget that is actually useful.
Here are 5 mistakes I see businesses make in the budgeting process:
ONE: Just Increasing Last Year’s Numbers by “X” Percent and Calling it Good
This is a common thing in budgeting. Take last year’s numbers and increase everything by 3%, or 5%.
This certainly makes the process simpler … but it’s not useful unless the percentage is based on some sort of reality and you know it really can apply across the board.
A better strategy — as annoying as it might seem — is to go line-item by line-item through the budget and come up with a current-year number that reflects reality.
When might the percentage method work? It could work for certain expenses such as utilities.
TWO: Creating a Monthly Budget that’s Just “Yearly Amount Divided by 12”
I recommend creating monthly budgets, but I believe strongly that the monthly budget must be based on reality, rather than just taking the yearly projection and dividing by 12.
I once was on a chamber of commerce board of directors, many years ago when I worked a totally different career. This particular chamber’s budgeting method was to do a yearly projection and then divide that by 12 for the monthly budget. This made planning and comparison almost impossible — the budget was basically useless on a month-to-month basis.
THREE: Not Accounting for Your Own Salary, Or Not Accounting for a Realistic Salary
It’s surprising how often this happens. I’ve made this mistake myself. The business owner either forgets to account for their own salary at all, or they set their salary so low that it’s not realistic.
For example, the business owner will set their budgeted salary at $1,000 per month, but they really need to draw out $1,500 each month. Each month their budget is off by $500 because they didn’t realistically assess their salary needs.
FOUR: Being Overly Rosy or Overly “Doom and Gloom” in the Budget
I’ve known a few businesses that try to be overly optimistic on their projections, usually because they’re trying to get financing.
Much more common is for businesses to use the opposite approach: expense projections are bare-bones and revenue is purposely under-estimated. I understand where people are coming from on this approach, but it’s not the greatest management approach.
A budget should reflect your best guess at reality. Of course it’s not going to be a 100% match because no one can predict the future. But you can make projections to do the best you can to predict what will happen.
FIVE: Not Being Committed to the Process
Creating and maintaining a budget is hard. I know from my own experience — it’s hard to set aside the time to create the budget. And even if you create a budget, you have to set aside time to update it and manage it.
One time I was helping a client who was going through a cash-flow crisis. He wanted me to help him create a budget so he could see where his money was going. But five minutes into the process, he declared that the meeting was useless. His business was fairly young at that point, and he declared to me: “no young business is profitable; young businesses consume resources and lose money, that’s just how it is.”
Thus ended our budgeting meeting. (See, this is why I repeatedly hit back at the experts who go on and on about “proactive planning.” Yeah, clients say they want proactive planning, but then when it comes time to actually DO the planning, suddenly clients decide they don’t want to work that hard.)