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Preparing a 3 way budget

Preparing A Three-Way - Budget that is

Reading time: 3 - 5 minutes

What can a business can do to make sure it is profitable and successful?...Without doubt, using an annual process called the Three Way Budget.

So What Is A Three Way Budget?

A Three Way Budget consists of projected profit & loss, cash flow and balance sheet. The business owner then asks "What would we have to do to make these numbers come true?"  This is the Aim of The Game.

Cash flow drivers hold the key to strategies to make sure there is enough money in the bank to generate profits to keep going. If the Three Way Budget is worked out correctly, all three statements should balance (i.e. talk to one another). You then have a clear picture of not only what your anticipated profit will look like, but also the amount that should be sitting in your bank account and finally your business's overall net worth. This is very very powerful and will give you an understanding of what areas you may need to tweak.

 

What Are The Steps in Getting Your Three Way Budget Completed?

Firstly, work out how much profit you would like to make using past and present information (such as management accounts, financial statements, changes in your industry, numbers of existing customers, average invoice value, number of transactions per year etc) and define your period to achieve these financial goals. This is usually done over 12 months although I also recommend that you start 3 years out and work backwards.

Secondly, establish what effect this profit will have on cash flow (the life blood of any business) and whether the business needs to have an injection of capital at some stage and/or introduce strategies that will improve money in the bank.

Finally, as a result of having information about the first two items, work out how much your assets and liabilities should improve by, after dividends, drawings etc and the make up of these assets and liabilities (a snapshot of your balance sheet).

Why Do I Need a Budget?

Many business owners think having a budget is a waste of time often because the future is almost impossible to predict.

However, if you set your budget to a desired level (not just last year plus 5% for example), you can then drill down and work out what sort of things you would need to do to achieve these results. This becomes a very powerful brainstorming session with your business partners, advisors and team who will now be thinking outside the square. Questions like "These are big numbers but what would we have to change in order for us to reach these numbers?". (Get your team involved and watch how motivated they will become as being part of the solution).

Of course if you are looking for finance, a carefully prepared Three Way Budget will impress your financial backers (whether they be the banks and/or investors) and increases the chance of monies being injected into your business whether it be at the start of the period or during the term of the projections as identified. Remember, it is always easier to get finance where you have determined it well in advance, rather than waiting on a crisis and then going to your financiers cap in hand. It also shows them that you have thought about the impact of your goals in advance and actually plan your affairs very well.

 

Why Do I Need to Look at Cash Flow?

Please be aware that whilst making a profit is a very good start, you CAN in fact go broke making a profit!

This is because the surplus may not always be converting to cash quickly enough meaning that there is not enough money to keep the business going into the next month, quarter or year. Cash flow stress can be due to monies not being collected quickly enough from your customers (customers are also known as debtors when they are given credit terms), invoices not being sent out in a timely fashion (left in the tray, billed at the end of the month), a hold up in work progress, paying suppliers too quickly (suppliers are also known as creditors when you are given credit terms) or when profits are tied up in stock for future sales or in slow moving stock items. You also need to make sure that if your business has debt which may have been created to make these numbers happen, the cash generated from the profits is enough to meet ongoing debt commitments.

 

In Summary

Don't fall into the trap of thinking budgets are theoretical fantasy lands. If you want to take your business and team to wonderful new heights, speak to Cliftons to assist you to get these done. Such an investment could literally mean better results by hundreds of thousands of dollars over a short period of time which means that you are reaching your targets to fund your desired level of lifestyle and in turn will make your business more valuable if ever you decide to sell.

 

Thanks to Pete Scolari of Scolari Comerford for the R&D

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