Numbers are just numbers, right? Wrong. Many new business owners assume that accounting is solely a record of data; you know, money coming in and money going out. However, you can utilize your accounting in numerous ways, especially when you set business goals. Today, we will show you how to set business goals, the difference between a budget and a forecast, and what to build into your business budget.
You may be wondering why this is important. Business goals that are poorly defined, or are not properly identified, will stand in the way of getting a clear foundation of knowledge where revenue is generated and where potential income is slipping away.
Everyone wants their business to perform well, but if their goals are garbage and their accounting is garbage, then (you guessed it), their output will also be garbage. When analyzing data and creating business goals, the purpose is to build a better understanding of your business; this includes your progress, failures, achievements, and the ability to identify your short-term and long-term aspirations to translate them into business-building steps.
Setting business goals is a balancing act. You want to shoot for the moon but also keep your foot on the ground. You must balance hope with being realistic. To do this, we recommend that you use the SMART method.
The first step of the SMART method is to choose a highly specific goal. In this goal, you need to write down estimates for “how much,” “by when,” and “what for.”
Next, you need to have a way to measure your goal. If you are keeping good books read here for a seven-step process on how to get your books in order, this should already be set in motion.
If your goal, with a brand new business, is to earn a billion dollars in one year, the chances of that happening are slim. This is where you must balance shooting for the moon while keeping your foot solid on the ground. You want to select something realistic that you can reasonably achieve while still having to push for it. Don’t make it too easy, but don’t make it so hard that it is impossible.
It is critical for you to pick a goal relevant to your business and its specific circumstances. There is no need to compete with others. Your goal should be a logical next step for your business to continue to grow.
Lastly, you need to give yourself a due date so you don't procrastinate. We highly recommend actually creating three goals: short-term, medium-term, and long-term. What do you want to accomplish in the next quarter? What do you want to achieve in the next year? What do you want to attain in the next five years?
Remember that these goals are not set in stone, and you can adjust them as you go. Speaking of, let’s move on to budget vs. forecasting.
In case you haven’t read it, we wrote an in-depth article about the difference between a budget and a forecast already. However, we will give you a snippet of that here for the sake of this article.
What is a Budget?
A budget is a goal. It is the plan you make financially for your business. If done correctly, your budget should have every aspect of the SMART method covered. So, when you are creating your business goals (i.e., your budget), make sure to take the time to really think it through.
What is a Forecast?
As we all know, life rarely goes according to plan. That is where your forecast comes in. As the realities of life divert you away from your original budget, your forecast demonstrates the changes and how you have adapted to them.
Our favorite example is that of a hiker climbing a mountain. The goal (i.e., budget) is to get to the top of the mountain. However, as you are making progress up the slope, you come across a tree blocking the trail. What do you do? You go around the tree. That little detour is your forecast. While your budget is still to reach the summit, your forecast takes every part of your journey into account.
Now that you understand how to set a business goal and the difference between a budget and a forecast, we will share with you a few items you should consider when building your business budget.
Step #1: Identify Revenue Drivers
Any product or service you offer that generates revenue and is reflected on an income statement is a revenue driver. These are the backbones of your business, so you must identify them properly. It would be best if you separated them appropriately and not lump them all together on your accounting software.
Step #2: Build Out the Logic
After you identify your revenue drivers, you should analyze how the products and services you offer impact your cash flow and income statements. From there, you need to determine how much you can build upon that.
For instance, if you are a lawn service company averaging five lawns a week, how much more can you do? Can you add another five jobs? Or ten? How long will those jobs take? Does the size of the lawn determine how much you can do? Take the time to think critically about your capabilities and what you can reasonably add to your schedule to build your revenue without, of course, burning yourself out.
Step #3: Identify the Direct Costs that Relate to Your Revenue
Nearly every business has costs associated with its revenue. Direct costs are crucial to determine the production value of products and services. Therefore, you need to break down the direct costs to be as detailed as possible to determine where those expenses are actually going.
Let’s take a look at that lawn service company again. The direct costs could include physical items like lawnmower payments, gas, eye protection, boots, clippers, etc.
Another example is the cost of an employee. You aren’t just paying their salary, but also included is their payroll expenses, workers comp, insurance, and more. You don’t want to just lump it all together as an "employee cost" in your accounting, rather separate it into different categories.
Step #4: Identify Indirect and Overhead Costs
In addition to direct costs, you have indirect and overhead expenses. These expenses can be both fixed and variable costs.
A fixed fee might be rent, as it is the same cost every month. A variable cost can be a pack of pens. You need to purchase a new box when you run out, but it isn't a constant need every month.
Whether your indirect costs include social media management, computer software, an office chair, or something else entirely, it all needs to be recorded, categorized, and tracked. By breaking it down as far as you can, you will provide yourself with the best overall picture of how your cash flow is performing.
Budget Design Tips
If you haven’t been keeping good books, you may find this information to be beyond your reach right now. We recommend that you use a quarterly or yearly average to get started and update it as your accounting improves. Remember, you should update your books every week, and at the end of the month, you should perform a comparative analysis to see how reality is holding up to your expectations.