A recent Palo Alto survey of thousands of businesses found that those with a business plan were around twice as likely to secure loans, get investment, and/or grow. Business plans can vary in focus and content, depending on their use. In this blog, I want to look at how you can use business planning to set up and track budgets for your business.
What are the different types of business plan?
There are two main types of plan that you might create:
1. External plans – that you use for banks, investors, grants, and partnerships
External plans require a lot more narrative. You’ll need to explain the background and context of your financial projections and clarify your market, approach, strategy, etc., as the people reading won’t be familiar with it. If you’re raising cash, you’ll have to explain why you need it and how you will spend it if you get it.
If you’re looking to prepare the kind of business plan required by a bank, investor, or funding agency, I’ve written two blogs on business plans that will help you get yours into shape: How To Write A Great Business Plan and Avoid The Trauma Of Business Planning With Liveplan.
2. Internal plans – monthly budgets for all the areas of the business, allowing you to review variance as part of your regular reporting
Internal planning is what I’m talking about in this blog. You won’t need pages of narrative to go with this, because the people who will be looking at this are already at the coal face.
Internal planning is easier than you think
Two of the main reasons businesses fail, even those that have been around for a while, are that they are undercharging for their products/services and/or overspending on costs. This is why a budget is so useful. It helps you to agree on what matters among the management team, and the great news is that you can do a simple budget within Xero, as we’ll see below.
For lots of businesses, planning overheads will be easy because these are either quite predictable or indeed a fixed cost. I’m talking about things like your rent, software subscriptions, kitchen supplies, etc.
Planning around services is a little harder. You’ll probably have an idea of how you’d like to see that revenue stream evolve, but it may also be affected by external factors such as seasonality. When you know what your target revenue is you’ll work backwards to account for the resources needed to make that amount of sales (cost of goods sold or salaries, for example).
Thinking about the breakdown of your costs and revenues can be really clarifying and help you define some KPIs for the coming year too. For example, a restaurant knows that their ingredients should be 25% of revenues and staffing should be around 35%. So, in planning for your sales, you’ve also effectively set a target for your cost of sales (food plus staff) at 60% of revenues.
What I want to stress is that setting up a budget for the year shouldn’t take you forever. When we do this with clients, it takes just two sessions – the first gets you to a draft budget, and a follow-up session soon after takes account of any feedback or research to adjust and finalise the numbers. It should only take a few hours, don’t let budget-setting become an interminable, open-ended discussion that you never see any results from.
As well as setting budgets for your outgoings and revenues, we also like to set targets for cash. I look at this in more detail in this recent post about targeting cash.
What’s the best tool for setting a budget?
Xero isn’t really a business planning tool. If we are working on comprehensive business forecasting – especially where there is also a cash flow budget, as mentioned above – we will probably use a third-party tool.
Lots of people use Excel or a similar spreadsheet tool for their budgets. Spreadsheets can be prone to various errors or issues and there’s a risk that you end up referring to a version of your plan that has long been superseded. This means spreadsheets aren’t our favourite tool for planning.
If you’re looking for an expert tool that will handle your forecasting, consolidations, currencies, and reporting, there a several good options out there, each with their own pros and cons. The main ones we see used are:
These will all be great if you also want to produce business plans, especially external plans, or if you need to also report on non-financial metrics such as general business KPIs. Liveplan is also good for helping to put together a business plan, as I’ve discussed previously.
What I like about using these tools is that once your profit and loss statement is done, your balance sheet and cash flow targets are automatically populated. When you do this in a spreadsheet, you’re starting from scratch for each.
But none of these tools is perfect, and the main issue with them is that usually data only flows one way – from Xero into the third-party tool. They also have a fairly steep learning curve, even for an accountant, which I think the typical business owner finds off-putting. I still haven’t found the perfect budgeting/forecasting tool and I suspect that in fact Xero will develop this functionality within the core product.
Use Xero to manage your monthly budget
If you don’t want the extra work and expense of using an external tool, you can use the budget manager in Xero to create a simple internal budget that supports your yearly business planning. You’ll find this under Accounting > Reports > Budget Manager. Put in a monthly budget for each account category (cleaning, entertainment, insurance, etc., depending on how your accounts are set up).
It’s quite a nice report because once you start updating the fields, you’ll be able to very quickly populate a whole year by either duplicating the amount each month, augmenting it every month, or changing it by a certain percentage.
You can also export this report to Excel or Google sheets, work on it there, and then upload it back to Xero when you’re done. This is such a neat way to have monthly budget information within Xero, because none of the external tools I listed are able to import such data back into Xero for you. Using a spreadsheet can be really helpful if you need to do some workings in the background, such as working out your staff cost breakdowns.
Now, when you do reporting, you can include a column to show your budget, so that you can see any variance each month. It makes sense to spend a little time creating this monthly budget in Xero.
What happens if my budgets are wrong?
Even if your budgets are way off, you can go back over the past months and see where you went wrong and by how much. If you didn’t have a plan, you wouldn’t even have a benchmark for this, making it all the more difficult to evaluate your assumption and decisions. It’s good discipline if nothing else, especially if you use our proactive approach of working in cycles and use the quarterly cycle to review financial health and, if needed, launch projects to course-correct or make improvements within the business.
It’s just an hour or two every three months to review the business and make changes that can be the difference between success and failure. I can’t stress enough that this is a much better way of managing your business than just logging into your bank account to see what your balance is at that moment in time and using that to gauge how well you’re doing.
Typically, you only need to create a budget once a year. Unless some massive shock has come along that changes the context and assumptions that went into your plan (Covid would be a good example), plans don’t need to be constantly tweaked and changed. I see this as almost counterproductive. Maybe you crush your targets, maybe they prove well out of reach; the best thing is to carry on with that variance and learn from it, so that you plan better the following year.