Realistic budgeting and the setting of effective credit terms are vital to keeping your business liquid.
Cash flow is one of the most important considerations when running a small or medium business (SMB).
Putting an effective budget in place and adapting your credit terms to fit your business is the best way to keep your finances, and business, on track.
In this article, we’ll be setting out how to budget and how to set business credit terms.
How to create a business budget
Despite its importance, businesses budgeting does not need to be complicated. The first step in creating any business budget is to answer three questions:
- What are your business’s projected sales for the period you are budgeting for? You might have to estimate these. If you do, try to be as realistic as possible, and err on the side of caution. The last thing you want to do is massively overestimate potential sales.
- What is the projected cost of making those sales? This would include the cost of the parts, raw materials, labor, equipment, and subcontractor services required to complete your sales.
- What are your overheads and fixed costs? When answering this question, try to break your overheads down by type, for example:
- Staffing costs
- Utilities
- Premises rental
- Various different types of expenses
- Legal costs
Depending on the type of business you run, there may be other business specific costs you need to include, but these three questions form the basis of any business budget.
You know how much money is coming in, what capital you need to make that money, and how much money is going out.
Key considerations when drawing up a budget
When drawing up a budget, there are several vital factors that need to be taken into consideration, including:
Make enough time for budgeting
Budgeting might not be the most exciting part of running a business, but it is hugely important.
Spending more time creating a realistic and comprehensive budget will ultimately make it easier and more profitable to run your business.
Only use your last year’s figures as a guide
Using your previous year’s figures to predict your future sales is a good way to estimate income, but they don’t represent any kind of certainty.
Collect and use previous sales data, but remember to filter them through your own plans, changes in the economic environment, the gain and loss of new customers and other important factors.
Using your previous year’s figures to predict your future sales is a good way to estimate income
Create realistic budgets
You should always be hopeful in your planning and far more realistic and conservative when you are budgeting.
One of the best ways to create realistic and accurate budgets is to invest in comprehensive accounting software, such as Xero, QuickBooks, and Microsoft Dynamics 365 Business Central.
Be flexible
While it is important that you try and stick to your budget as much as possible, the reality is that conducting business is a flexible situation.
You shouldn’t stick to your budget if it blocks you from business opportunities and should review it regularly to monitor performance.
What are the benefits of business budget planning?
There are several benefits to realistic business budget planning, including:
- It helps you define goals - Having a good grasp on your financial situation can help you define realistic long term goals and set aside the required capital to achieve them.
- It keeps you solvent - Having a budget makes sure you don’t overspend. That might seem simple, but it can also be entirely critical. Most small businesses operate on very thin margins and significantly deviating from budget can have devastating results.
- It improves your decision making - Having a solid and realistic budget in place means you have a foundation on which you can base your business decisions, meaning you can make decisions faster and more confidently.
- It helps identify problems in advance - Regularly reviewing your budget can help to flag up any financial problems in advance and allows you to address them before they become more significant.
Setting effective business credit terms
Connected to setting a realistic budget is setting effective business credit terms. A credit term is the time you allow for your customers to make payment on the goods or services you provide.
As a general rule, these tend to be in multiples of 30 days, such as 30, 60, or 90. However, there is no specific industry standard.
The exact credit terms you set will depend on your specific business needs and what you want to achieve.
Establishing a credit policy
Your credit policy is a credit management document that sets out the credit terms you plan to offer your customers. There are two types of credit policies, internal and external.
- An internal credit policy is a set of guidelines that aim to prevent staff from offering lines of credit to customers who are unable to make payment.
- An external credit policy is one that sets out your specific credit terms for your customer.
This document might include credit control measures such as the need for a business credit check, supplier references or other information that is used to establish a customer’s creditworthiness.
Key considerations when establishing a credit policy
When you are establishing a credit policy for your company, there are a few considerations to bear in mind, such as:
Don’t be too strict
Many businesses offer credit terms as a way of attracting new customers.
Offering goods or services on credit is a great way to encourage new customers to trade with your and existing customers to make larger purchases.
While it might be tempting to simply not offer any credit for safety sake, you might actually be harming your business if you take this approach.
Don’t be too lenient
As we’ve already discussed, cash flow is hugely important to smaller businesses, so the benefits of offering credit to your customers needs to be weighed against the delay in payment they will cause.
Offering overly generous credit terms can lead to significant drop in liquidity, especially if your customers don’t pay within those credit terms.
Implement effective credit control
If you do plan to offer credit, implementing effective credit control is particularly important.
Credit control platforms like Chaser use cutting edge automation, alongside a huge range of other innovative features, to help you keep a consistent cash flow.
Chaser users, on average, save more than 15-hours per week on credit control management, get a 25% reduction in Days Sales Outstanding (DSO) and get paid 16-days sooner.
Offering trade discounts
One of the options when setting credit limits is to offer your customers a trade discount.
A trade discount is a method of improving cash flow by offering customers a discount on their bill if they pay within a certain period of time.
These discounts don’t tend to be large, only around one or two percent, but even small discounts can build up over time, making them a significant incentive for your customer to pay faster.
The advantage of offering a trade discount is that it works hand in hand with offering credit to encourage customers to place larger orders and also encourage them to make payment within a certain time.
The primary disadvantage of offering a trade discount is that it represents another complication to your business budgeting. The cost of any trade discount needs to be taken into account when budgeting.
In turn, you need to have a realistic budget in order to assess if the potential increase in business granted by offering credit and the cashflow improvements offered by trade discounts offset the overall risk and loss of earnings.
Setting effective budgets and credit limits
As you can see, budgeting is not necessarily a hugely complicated process. However it is a business critical process. But setting a realistic budget, you create a firm foundation from which to make better business decisions and move forward with attaining your business goals.
Intertwined with budgeting is setting effective credit limits and offering trade discounts. Having an effective budget in place can help you understand the business impact of offering credit and the cashflow incentive of offering trade discounts and weigh them against the possible risk of non-payment and the drop in total revenue.
When it comes to offering credit, having effective credit management in place is a must. Chaser is an award-winning market leading credit control platform that has helped thousands of small and medium businesses stay liquid.
Book a demo or a free trial with us today to see how Chaser can help you!
