I was fortunate enough to have a piece on business budgeting published in the farm finance section of the Irish Independent on Tuesday 8th of February 2022: https://www.independent.ie/business/farming/agri-business/finance/farm-budget-a-practical-guide-to-c...
I thought it would be a good idea to record it as a podcast episode to share with listeners. Budgeting at its core remains the same whether it’s business or personal finance. The same fundamental principles ring true.
Contrary to popular opinion, embracing a budget is empowering and fosters an enviable level of self-mastery. Budgeting provides structure and accountability. In the absence of a budget, spending usually rises to meet income. Will power alone is generally insufficient. Being bad with money is a pain, being good with money is a pain, initially. Pick your pain.
Budgeting is a plan for income, spending and therefore profit. It spans your past, present and future. We can learn from the past, take action in the present and plan for the future. It is the foundations on which to build a sustainable financial future. I would go so far as to say, budgeting is 80% of being good with money.
Money is a tool. Budgeting is putting that tool to work, giving every euro a job. What we can control and what we can’t control, theory versus practice. Budgeting is more of an art than an exact science. The real world is an evolving environment in which the goal posts are constantly changing. Therefore, budgeting is a process of refinement through learning and tweaking over time. So, where to start? We start at the end and work back.
Your personal goals will drive your financial goals which in turn drive your professional goals. Budgeting aligns your financial resources to your personal goals via your professional goals. Goals give you a target at which to aim and instructs your budget to make your goals a reality.
The goal of a business is to make a profit. The goal of profit is to transfer business success into personal wealth. The goal of personal wealth is to have a comfortable lifestyle and save for financial independence. The goal of financial independence is the day you choose to work rather than having to work. The freedom and security of being financially independent is a major milestone in life. These goals are generic but the application of these goals to your circumstances will make them specific to you. The more granular your goal is the better. Aim small, miss small. Break your goals down into manageable steps. Starting is the most important step.
Habits are the repeatable tasks that compound to meet your goals. Designing systems and processes that foster good habits is the ultimate objective. We are what we repeatedly do, excellence then is not an act but a habit - Aristotle. The trick to designing good habits is to make them visible, attractive, easy and satisfying.
Here are some business goals:
· Spend less than you make by creating a profit margin
· Allocate part of current income to future spending
· Build a small cash buffer
· Become debt free
· Build an emergency fund of 6 months of expenses
· Insure yourself and the business against the known unknowns
· Transfer business profits into personal wealth
· Future proof & grow the business
· Sell the business
Your time is finite whereas money is infinite, therefore time is your most valuable asset. Because time and money are exchanged for one another both need a budget. How you allocate your time across business priorities is very important. Budget your time in the same way you budget your money. Audit and allocate your time to what matters most to the business. Are you getting a sufficient return on your time?
Being organised is underrated. How organised you are generally, will be reflected in your spending. Keeping bank accounts to a minimum will make tracking and managing them easier. Lean on your bookkeeper, accountant or family member. Use separate bank accounts for business and personal use. Streamline and automate how you spend and save. Automating your finances removes the need for will power alone to make good money decisions. Decision fatigue refers to the deteriorating quality of decisions after a long session of decision making. As energy levels wane throughout the day the quality of our decision-making declines.
To look forward we first need to look back. Does the business spend what it earns, more than it earns or less than it earns? Knowing and understanding the answer to this question is half the battle. Subtract spending from income during each pay cycle, ideally over the past two years. Past spending is usually a good indicator of future spending. If the business spends what it earns or more than it earns it will need to spend less or earn more. Creating a profit is the goal.
One of the biggest pitfalls when it comes to budgeting is less frequent future spending. Less frequent future spending is irregular spending that falls outside of daily, weekly and monthly spending. Examples being insurance and a company car. Carving out a portion of your regular income for your less frequent future spending will mean you are prepared for those expenses ahead of time. Synchronising your income with your short-, medium- and long-term spending by saving into a sinking fund for future bills. Divide the number of pay cycles between now and when future spending comes due and set aside the required funds from each paycheck. This will be the true test of whether your budget is affordable or not. Borrow from your sinking fund and not the bank.
We typically have greater control to reduce spending as opposed to increasing income. The best an expense can go to is zero. Prioritise spending from most important to least important and explore lower cost options, alternatives and substitutes. Get creative. If there is no room to reduce expenses, you’ll need to increase income. Focusing on profitability you can increase prices, production or expand your offering. In an ideal scenario you would focus on reducing spending and increasing income at the same time. Setting your spending floor as low as possible and pushing your income ceiling as high as possible. The taller the room the better. Budgeting is a zero-sum game unless you increase income or sell an asset. Increasing your income is of course easier said than done.
Debt is a substitute for saving and more expensive due to the interest paid. It adds financial risk to your business. Debt is often used in the growth of businesses on the pretense that current circumstances and projections remain unchanged throughout the repayment term. It is important to be conscious of the risks. Debt means borrowing from future unearned income to pay for today. A businesses income is one of its biggest financial assets. Debt repayments are a drag on business income. Below are three debt reduction strategies to free up cashflow:
The debt snowball prioritises debts with the lowest outstanding amount first all the way down to the highest outstanding amount last. Maintaining minimum payments on all debts while concentrating all surplus financial resources on reducing the smallest outstanding amount first. Once the smallest outstanding amount has been repaid, you then channel the old repayment amount into the second smallest outstanding amount. Repeat the process until all debts are eliminated. While this isn’t the most financially optimal approach research suggests it is psychologically optimal given the quick progress from paying off the smallest amount first.
The debt avalanche prioritises debts with the highest interest rate first all the way down to the lowest interest rate last. This is the most mathematically efficient approach and will save you the most time and money.
The debt tsunami prioritises all debts with the highest emotional significance first all the way down to the least emotionally significant last. Family or friend gatherings can be uncomfortable if you have an IOU hanging over your head.
The right one is the one that works for you. It could be a combination of all three. It is not unusual for lower amounts of debt to be high interest rate debt and higher amounts of debt to be lower interest rate debt. Therefore, the debt snowball might overlap perfectly with the debt avalanche.
Inflation is the increase in prices over time. Inflation is measured by the Consumer Price Index and saw an increase in prices of 5.5% for 2021. Recent price rises across the board but especially utilities and transport mean rising costs for businesses. There also appears to be upward pressure on wages. When budgeting a business can choose to absorb the increase in costs or pass them on to consumers. A business’s focus should be on costs plus profit equal’s price. Interest rates look likely to rise in an effort to curb inflation. If interest rates rise debt becomes more expensive therefore reducing the level of borrowing. Less liquidity in the system and an incentive to save money rather than borrow means the flow of money in the economy slows.
Set goals and form habits that compound to achieve those goals. Value your money by valuing your time. Refine your budgeting to know the short-, medium- and long-term costs of your business and reconcile this with income. Debt adds financial risk to your business. Inflation has been dormant for over a decade and now needs to be factored into your budgeting and business model. Focus on the inputs and the outputs should look after themselves.
Link to Spotify podcast episode: https://open.spotify.com/episode/35VGmhZlFTHXNZKUzpXKNd?si=73972379144e474a
Link to Apple podcast episode: https://podcasts.apple.com/ie/podcast/s2-e12-business-budgeting/id1539630506?i=1000553503901
For personal financial planning advice email email@example.com or call (01) 539 2670.