By Beth Whitmore, Partner at Wellers, one of the UK’s leading accountancy firms, offers his advice on how to mitigate against rising costs and inflation.
Businesses are facing the highest rate of inflation for 30 years, which is having a substantial impact on costs. Following Brexit and amidst supply-chain challenges resulting from the pandemic, this economic uncertainty shouldn’t be a huge shock. But the extent of rising costs is almost unprecedented and could present problems for several years to come.
Energy prices have hit the headlines of late, but materials costs and supply chains are also impacted.
Much of the conversation surrounding rising costs has focussed on consumers, with family income predicted to be tighter than ever. But it potentially poses an even greater threat to businesses with the Federation of Small Business (FSB) warning that these rising costs could pose an existential threat to many.
When it comes to energy prices, the problem for businesses is that the energy price cap doesn’t apply. So, in theory, suppliers can charge whatever they like. Whilst this is less of a problem for big organisations that have large purchasing powers to negotiate good deals, small businesses don’t have the same sway or influence.
All of this means that having a business budget has become one of the single most important things a business can do. When it comes to budgeting, there a few things to keep in mind:
Understanding what budgeting is
Essentially, a business budget is a financial plan, often based on historical data, to track the income and expenditure of a business.
As part of this process, goals can be set for revenue and expenditure is predicted. This makes the process essential for business owners so they are aware of what the future looks like, and they can then make informed decisions. This can be on a range of things including investing in new equipment, hiring new staff, or moving premises. It can equally assist in managing business debt, reducing loans, or securing finance.
Managing a budget
The challenge with budgets is they are often viewed as the property of the finance team. In reality, they are the responsibility of the finance team plus directors, department heads, office heads, and office administrators. This is to ensure budgets are regularly consulted to help with spending decisions and are continually updated throughout the year.
Creating a budget
There are seven main parts to creating a budget:
To create an accurate budget, it needs detail. Without this, it will become a guessing game to predict turnover and the spending required to achieve it. It’s essential to analyse historical spending, resource requirements, turnover, and cash flow.
2.Sales and revenue projections
Sales data from previous years can help make revenue projections for the next business cycle. The projections can then be used to set targets for salespeople, so can be broken down by day, week, or month.
3.Identifying fixed, variable, and sunk costs
Costs are always a potential risk. All businesses will have some costs attached to them, but it is wise to keep an eye on them to ensure they do not outstrip revenue, especially in times of high inflation. There are three types of costs – fixed, variable, and sunk. Being aware of a business’ different types of costs is important so directors are aware of what they can and cannot control. It also means business owners can identify if they need to negotiate new rates.
Fixed costs are regularly payments at a consistent price. They include:
- Equipment lease payments
Variable costs will change depending on use and market fluctuations. They include:
- Raw materials
Sunk costs are infrequent, one-time amounts of expenditure. For example, many sunk costs occur in the early phases of starting a business, or when a company is preparing for the next stage of growth. New equipment is a good example of this.
Salaries and wages are often a business’s largest expenditure so it’s important to plan how many employees the organisation currently has, and how many it needs to facilitate future operations and reach revenue goals. You may need to invest in new people to hit sales targets, but equally a department head may be pushing for more staff instead of addressing inefficiencies.
5.Assessing profit margins
Tracking income versus projections and expenditure against budget allows a business to predict profit margins. Although a business doesn’t need to make a profit to operate, profits indicate a healthy enterprise and facilitates growth.
6.Profit and loss statement
A profit and loss statement works by subtracting total expenses from earnings and will determine if a business is in profit or not. A positive number indicates profit, negative indicates loss. These stats are essential to feeding into future budgets.
7.Trends and seasonal trading
Businesses that rely on seasonal trading with big peaks and troughs will need to plan for this, particularly for cash flow and headcount management.
Monitoring the budget
Once the budget is created, whether it’s forecasting for a year, two, or maybe even five, it’s critical to refer to it often. Revisiting the budget often allows business owners to note overspending or underspending and identify cost changes. It means the financial health of a business is always known.
The worst thing to do is ignore the budget once you have created it. In the current business landscape, not being aware of profit and loss, could be detrimental. If you ignore a leak, it’ll become a burst pipe before you know it and at that point, it’s much harder to stem the flow. If you need advice on how to manage business finances during these inflationary times, speak to your accountant who will be able to offer you practical advice on what to look for and what grants will apply to your business.
Visit the Wellers website to find out more about business budgets.