You know me. I am all about strategic planning. I blog about it, talk about it, dream about it, blog about my dreams about it. I like strategic planning. I think it’s crucial for small businesses. So it is only logical that I would be a huge proponent of budgeting because that is one of the crucial elements of… you guessed it, strategic planning.
Annual Budget Projections For Small Businesses
Every small business should prepare an annual budget projection of what the year is going to look like. Budget projections should also be done when starting a new business or rolling out a new product/project. Preparing for the year ahead just makes solid business sense.
For those business owners who do annual budget projections, I am going to discuss a very important concept called “budget stress testing.” Very rarely will your budget go exactly as you have projected it. But if you have stress tested it, you’ll find that you are much better prepared.
Business Budget Stress Testing
Stress testing is a tool that we bankers use all of the time. We use it to assess the risk of a project or a business, so we know what the impact will be if things don’t go exactly as planned. An example would be a client who is purchasing a piece of investment real estate. If the client is requesting a 20-year loan to purchase that real estate, we must consider what might change over the course of the next 20 years. What might change that would affect the viability of this loan – interest rates may rise, property values could drop, average rents could go down, vacancies could go up, etc. We stress test the loan using “what ifs” like these to determine the financial feasibility of the loan and the purchase if things change in the future. While this is a long-term example, this type of stress testing can be performed over the short term as well.
It’s the same thing with your business. Let’s look at an example of practical application of stress testing to an annual budget:
In your annual budget, you project growth of 20% based on expanding some relationships and bringing on some new clients. Based on this, you decide to upgrade some of your systems, at a significant cost. But you apply the stress test – what happens if you lose a big client, or your main supplier increases their prices 10%, or your health insurance rates skyrocket? These are all very real possibilities over the course of the next year. While none of them may put you out of business, they could definitely impact your income statement, your balance sheet, and potentially your line of credit and your pricing. So factoring in your stress testing, you might consider reducing the amount you spend on upgrading your systems. Or you could prepare for these contingencies in some other way. The point is, you have projected for the best, and prepared for the worst. That’s stress testing your budget.
Ultimately, it is better to be proactive and intentional in your business as opposed to reactive. I believe that stress testing your budget for the upcoming year, a new project or product, or even a new business can be very beneficial for your business in anticipating problems down the road.
If you’d like to discuss how to stress test your budget projections, feel free to reach out to me. And if you’d like to hear the song I’ve written about strategic planning, stop by the office. I’m sure my co-workers wouldn’t mind hearing it again.