The effectiveness of a business owner’s ability to plan is vital to a company’s success. Budget planning is a critical piece of the planning process. Budgets are dynamic and flexible plans used to estimate future income and expenses
Tips for Budget Preparation
Your budget needs to include all sources of income and expenses for the upcoming desired period, usually a year. It should be detailed but also realistic, providing the essential information needed to run your business within its mean, face unexpected challenges and help you anticipate revenues. Remember to plan for long-term items too. If you know you will need to purchase a large amount of equipment in two years, it is best practice to start budgeting for them now.
Budgets allow you to set more precise goals and priorities. You will clearly see where you may want to implement new strategies for increasing revenue or cutting costs. Depending on your company size, you will want to use past revenue and expense amounts to estimate the anticipated future amounts for the next month, quarter, or year. If you have separate departments in your organization, they should all have a separate budget that feeds up to your master budget. A master budget is the overall financial plan for your company and includes two sub-budgets, operating and financial. Having a strategy for distributing your revenue most effectively over a full fiscal year will help maximize profits.
Beyond just the planning process, budgets are needed to evaluate your company’s performance properly. Several different types of budgets can accomplish this:
- Static budgets: Static budgets are operating budgets that use historical financial data to budget for revenue and expenses expected in the next period. Typically used by smaller businesses, these budgets require taking each line item and adding a percentage increase or decrease to reflect the next budget.
- Performance-based budgeting: This type of budget considers the inputs and outputs per unit of product or service to achieve maximum efficiency.
- Zero-based budgeting: A zero-based budget starts from scratch every period and builds a new budget based on the conditions at that time. In other words, it starts from zero for each line item and uses internal and industry financial data to build the budget.1
- Variance analysis: A variance-based budget is one where actual and expected values for every revenue and expense item is calculated. The results are used to try to bring the budget items back within a specific range and achieve improved efficiency2
Budgeting to Obtain Financing
A history of creating detailed and sound budgets then sticking to them can help your business obtain funding from lenders and investors. They are one more tool to show your competency and business is working. Lenders and investors want to dig deeply into your finances and history, and if they don’t see evidence of solid budgeting practices, it might be a red flag that would turn them away. Even if you are a new business with no track record, having a clear and concise budget that is well researched and based on marketplace trends will help lenders and investors take you more seriously.
Benefits of Budgeting
The benefits of business budget planning are many. Here are some of the most important:
- Financial health: Without a business budget, you can’t know your company’s financial health. You would have no idea if you met or exceeded your goals.
- Strategic planning: A business budget allows you to develop a strategic plan since you will know the answer to issues like expanding.
- Obtain debt financing: If a small business tries to obtain debt financing from a bank or other financial institution, it must produce a budget to show potential lenders.
- Attract investors: If a business wants to attract investors, they will not put their money into the company unless they can see a budget.
- Tax preparation: A business budget assists in the preparation of income, sales, and payroll taxes.
- Decision-making: To make decisions about any facet of the business, you must know how much money is allocated to that item.