How to budget for long-term profitability

By Jack Dixon | Senior Consultant For many small and medium-sized businesses, the internal CFO function is an unnecessary and unaffordable expense. This, coupled with easily accessible financial management software tools, means that business owners are increasingly managing their ongoing financial affairs—including business budgeting—in isolation. However, without an experienced advisor to work as a sounding board, this approach can have negative consequences including poor cash flow and stunted business growth. Here are some critical budgeting steps that you should take to ensure your business is operating sustainably and, more importantly, set up for long-term success.

The first hurdle

The key to successful budgeting for profitability is having high visibility of your entire financial picture. You need to set your goals, track your incoming and outgoing funds, measure your performance, and plot out your business trajectory over the next few months and years. The first step, and often hardest for many business owners, is to set realistic goals for your organisation. Choosing a number out of the sky for next year’s sales goals or creating a growth plan for percentage increases each month isn’t realistic. Your goals should be based on your past performance, and you should carefully consider all the costs that may increase as your business grows. Remember, it’s likely that the more sales, the more money you’ll need to spend in order to drive those sales—and that includes marketing costs, material costs, warehousing costs and more. It’s great to be ambitious, but you’ll never meet your goals if they’re unrealistic in the first place. Here at CharterNet, our virtual CFOs (vCFOs) often perform “sense checks” for our clients, ensuring they’ve not only set goals—but that those goals are appropriate and based on facts and reasonable assumptions. Thanks to their deep experience across industries and sectors, our vCFOs are trained to identify vital errors right away—allowing the business owner to course-correct and start managing their finances more effectively.

Budgeting basics

Once you’ve established reasonable and informed goals for your business, you next need to implement the right tools. There are hundreds of accounting programs out there but, at CharterNet, we prefer powerful cloud-based platforms such as Xero. Xero includes everything from bookkeeping tools and payroll tracking to expense reports, invoicing, inventory management and more. You may also use more basic tools like Microsoft Excel, but you’ll definitely want to have a pro’s advice if doing so. They can ensure your spreadsheets are set up properly and that you are tracking the right metrics, numbers and goals. In budgeting, your ultimate goal is to list all your incoming funds and outgoing expenditures for the month, determine your gross profit, and subtract the total operating expenses you’ve incurred. Incoming funds include any sales or means of revenue. You can take one of two approaches to tracking your incoming funds:
  1. Look at the last 12 months of sales and determine an average for each month.
  2. Look at expected payments and sales coming in. (This is easier if you have a subscription or retainer-based model.)
Outgoing costs fall into two categories:
  1. Fixed or predictable costs, which include your office rent, your payroll, your benefits, and anything else that’s pre-established and expected.
  2. Variable costs or, as we call it, ‘cost of sales’. These include any costs associated with lead generation and conversion, product manufacturing and storage, and marketing and advertising. They typically change on a monthly basis.

Tackling cash flow problems

The important thing to remember when budgeting is that cash in your pocket doesn’t necessarily mean that you’re profitable. There are still dozens of operating costs, sales costs and other expenses you have to deal with—and those all eat into the total profit your business can derive. If you’re not careful to track and prepare for these expenses, you could find yourself facing cash flow shortages at the most critical times—something which many business owners deal with when they lack a CFO function in-house. Here a few things you can do to ensure you don’t face cash crunches:
    • Consider your payment terms. The old “30 days or more” payment requirement is outdated. With digital payment tools and online banking, you should expect clients, customers and vendors, in most situations, to pay up within a more reasonable timeline. This ensures cash hits your account more regularly and that you can pay your bills or other revenue-driving expenses before incurring any late fees.
    • Stall payments and hold on to your cash. Just because you have money in the bank doesn’t mean that you need to spend it right away. If rent isn’t due until the 31st, wait until the 30th to pay it—and keep that cash safe and sound in your account. The longer you can keep that financial safety cushion there, the better off you’ll be.
    • Stay on top of your debts. Know who you owe and what you owe them, and work consistently to pay down those debts over time. Have a set repayment timetable on the books, and create a reliable, consistent schedule on which you make installments.
    • Chase up your debtors. Often, this is where most cash flow issues occur. It’s important to stay on top of invoices that you’ve sent out and when they’re due. When dealing with customers and vendors, consider including late payment fees or interest charges in your terms and conditions to cover the cost of credit card interest fees or administration time.
    • Know your tax burden. It’s vital that you understand your company’s tax obligations and that you put aside a portion of each payment you receive to put toward that burden. It might only be paid once a year, but you don’t want to end up scraping for funds come tax season (or paying late penalties if you can’t).
  Not preparing or saving for tax debts is one of the biggest missteps we see from business owners nowadays—especially those who don’t have a dedicated VCFO. Preparing for your tax payment throughout the year, as well as following these other simple guidelines, can help you get your cash flow in place—and remove that pesky temptation to dip into savings.

Steering toward long-term profitability

Once your tools and cash flow are in place, it’s time to prepare for the future—and this requires regularly tracking, measuring and analysing of your performance. Don’t wait until your business activity statements or tax returns are due to assess the health of your finances. Instead, month over month, you should look at: How is your business performing? Break down your profits and losses each month, and spot seasonal trends that can guide your strategy. Who’s contributing? Measure the contributions of each department and division to your overall revenues. Who’s outperforming who? What areas need a change? Where should you focus? Look at your income by customer, and find out who’s worth your time and resources in the long-term. Can you stand the test of time? Determine your burn rate—how long your business could survive if you stopped operating tomorrow? How are you measuring up? Compare your budget and actual expenditures to determine how effectively you’re spending your cash.    
Measure your income by customer and find out who’s worth your time and resources in the long-term.
This is where a vCFO can come in handy, offering you professional analysis and guidance on your company’s actual, real-time performance.  Unlike an in-house CFO, which comes with a full salary and benefits package, a vCFO works on a part-time basis. They offer you the insights and clarity you need to look in to the future and drive your business forward, without requiring a huge investment of funds or resources.
Actual vs Budget table image
Using real-time visual data analytics, we’ll help you compare your budget and actual expenditures to determine how effectively you’re spending your cash.

A virtual CFO can help

A vCFO can also help you understand which Australian Government grants and cash-back schemes are available to you, prepare you for future sales or mergers, provide networking opportunities with other like-minded business professionals and, overall, just better understand your data and numbers. Contact CharterNet today for an obligation-free consultation about our vCFO service.