Financial Planning: How to budget for an uncertain year ahead
As we come to the end of 2021, its time to start thinking about the budget for next year.
One thing is certain – uncertainty.
Business planning and budgeting have become increasingly complex in today’s uncertain and volatile environment. Firms have had to adapt and become more agile in order to react quickly to changing market conditions and budgets should be created with this in mind.
Start with your fixed costs – the things that you can be certain of such as premises, staff costs, raw materials, light, heat, electricity, IT, etc. Next, turn your focus to the longer term aspects of your budget with an analysis of existing strategic or capital spending plans.
Stress test the assumptions, scenarios and decisions that have gone into your draft budget. What if your sales don’t grow next year? What if your annuity income falls because 10% of your customers leave and go to another provider? How does this affect the profitability of the firm?
In uncertain times, it is important to be pragmatic. Create 3 scenarios for your budget – high, medium and low. Start with the medium scenario – the “expected” outcome and from there you can derive variations on whether things turn out better (high) or worse (low).
Scenario-based budgeting is not intended to predict exact outcomes.
Instead it is intended to help the business to understand the likely variances and prepare accordingly.
Hold back some spending centrally as a contingency. This builds some flexibility into the budget so that the business can react to changing circumstances as the year progresses.
Calculate your budget using new data, not historical projections. Budgets may have been squeezed in the past 18 months and may not reflect the current or predicted market trends.
Finally and most importantly, build realistic income models. Ensure you provide for bad debts and write offs in each of your high, medium and low scenarios. Cash is king and in uncertain times every business must focus on getting cash in on a monthly or even weekly basis. Billing cycles and cash collection management should be at the top of the agenda for the management team and offering extended payment terms to customers should be avoided as much as possible.
Build these principles into your budget and ensure you keep adequate reserves in case you encounter