Budgeting is a critical part of your business roadmap. Your business risks going astray if you don’t stay on top of finances from the beginning.
Not only does the budget help to keep the financial health of your organization in check, but it also directs the course of action for business functions.
A budget gives an overview of your finances, including revenue, expenses, and other components over a specified period. Creating a budget is essential for ensuring a strong financial position of your business in the present and future.
Let’s discuss in detail why you need a budget and how to create one.
Budget tracks, controls, and guides
A budget has two main functions – planning and control. The budget, being an outline of the complete financial status of your business, helps you see the bigger picture and aids your decision-making.
Here are some key benefits you can reap by creating your budget.
The revenue forecast is one of the primary goals of the budget. It helps you visualize how much you can expect to earn in a given duration.
The merit of such forecasting is that you can plan your move accordingly to maximize your profits. Suppose your expected revenue is 30% more than the previous year. In that case, you might want to spend more on ads to attract more customers.
Making informed decisions
Most of your business decisions have to have some monetary implications, whether investing in new software or optimizing your marketing efforts.
Creating a budget helps you judge the ROI of your investments. It also enables you to gauge your financial capacity, anticipate problems, and reveal areas of improvement. Thus, a budget can provide the necessary information to help you make informed decisions.
Cost control is key to a profitable business. No matter how much revenue your business earns, your business might be in trouble if your costs outweigh your income.
The budgeting process builds the foundation for cost control. It helps you identify business expenses and serves as the starting point for relevant action. For example, you can think of cutting down infrastructure expenditures or vendor negotiations to optimize raw materials costs.
Budgets are a valuable benchmarking tool for your business performance. You can use the budget figures to monitor and compare performance yearly, quarterly, or even monthly.
It can also help you set practical future goals taking the figures as key performance indicators. For instance, if you see one of your products consistently bringing in much less revenue, you might decide to focus on it more or scrap it altogether.
Budgeting is also an excellent tool for gaining new financial opportunities. The budget figures indicate your business’s growth potential. It helps you back up your pitch with data to convince investors to invest.
Before moving on to the steps to creating your budget, let’s get you familiar with the fundamentals to base your budget on.
Determine the budget type
To start with, you need to figure out the type of budget you need to create. Depending on the purpose and functional areas, businesses commonly use the following budget types.
A master budget is the complete overview of the finances of a company. It includes the figures, and projections of overall income, cost heads, operating expenses, assets, debts, cash flow, etc.
This type of budget gives a comprehensive financial picture of an organization. It helps align all the business functions.
A static budget type, as the name suggests, considers fixed expenses and revenues. This type of budget means creating a budget based on how much you have in hand and how much you’ll spend.
Though this budget type may not reflect accurate estimates over the period, it gives a good starting point or guideline for realistic forecasts.
A flexible budget considers both the fixed values and variables associated with expenses and income, unlike a static budget. It adjusts the numbers based on actual current figures. Thus, it gives a more accurate financial picture.
Since a flexible budget is based on the current period’s figures and forecasts based on multiple scenarios, it can help you better prepare to tackle the outcomes.
An operating budget covers the expenditure and income generated from day-to-day business operations, such as the cost of producing goods or services, related administrative costs, and revenue from the goods or services.
This type of budget doesn’t consider long-term debt or capital expenditure. You might want to create this operational budget if you want to look at your day-to-day operations’ financial implications closely.
A budget can be made for every department or functional area of your business – for example, HR budget, marketing budget, and others.
If you have a larger organization, creating a separate budget for each department can help you allocate and plan activities accordingly. It can also help you evaluate the performance of each department.
Decide on the budget period
Typically, a business budget is created for a year. However, there is no hard and fast rule. You can create budgets for a shorter or longer period depending on the need.
You can start with a budget for two or three months or break your annual budget into monthly or quarterly periods. No matter the length of your budget period, the more critical task is its routine review. Also, you can make amends to your budget as you go along.
Creating your budget
Once you’ve decided on the type and period for your budget, it’s time to get into action. Let’s first look at the components your budget should include.
Costs and expenses are integral to the budget. There are three main types of costs a business incurs:
These are the consistent business expenses that don’t change over a period of time or with respect to other factors. The fixed costs of your business typically are:
- Leasing costs
- Utilities like internet or phone plans
- Website hosting
These are the expenses that change according to volumes, usage, or other factors. Also, variable costs have the maximum room for cost control. The variable costs your business is likely to encounter are:
- Raw materials costs
- Electricity or fuel bills
- Travel expenses
- Sales commissions
- Shipping costs
- Advertisement spends
These are the expenditures that a business incurs once or less frequently, usually outside the usual business activities. These expenses may even be unexpected. So, it’s better to predict them or set some amount aside to be on the safer side.
The one-time expenses include:
- Office furniture and equipment costs
- Repair or replacement costs
- Product launch cost
- One-time consultation fee (e.g., hiring an expert to help you with product ideation)
Once you’ve accounted for all the expenses, it is also important to set spending goals for the future, both short-term and long-term. Setting goals will help you develop your budget and control costs accordingly.
Along with costs, revenue is the crucial component to include in your budget. Revenue is the income your business brings in each month.
First things first, you need to list down all the income streams of your business. These will include:
- The products or services you sell
- Interests you earn from renting a business asset
- Additional services or activities that bring in money (such as the registration fee for an event)
Next, based on past sales figures or general trends, you need to determine the amount you expect to earn month-over-month from each of your income sources. However small an income source, make sure you account for each of them.
Cash flow is another crucial component to consider in your budget. It is the account of cash that goes in and out of your business daily.
Cash flow is vital to keep an eye on your financial position at any point in time. Reviewing your cash flow weekly, or at least monthly, helps you find out if you have enough cash to pay for the costs, interest, and other expenses.
If not, you can immediately act to bring in more cash for continued business operations in times of crisis- by taking a loan or selling an asset.
Including profit figures in the budget can be very useful for your business growth. Profit is what remains after deducting your income from expenditures.
The expected profit margins direct you towards growth by revealing the possibilities. If your profit margins come out to be lower than you’d expect, you can rethink how to improve profits. If the profits are higher, you can focus on encashing it to scale your business.
The essence of a budget lies in its ability to get a glimpse of future possibilities through projections. Projection is estimating the figures based on present trends.
Projecting your income, expenses, and profit month-on-month or year-on-year gives you a peek into what to expect and where to improve. Along with the past and present trends, you can base your projections on industry trends and your business goals over the period.
Not to mention, your estimations have to be realistic. Unrealistic estimates will not only give the wrong projection but also derail your overall business goals.
Presenting your budget
Once you have gathered the figures for income and expenses, comes the time to bring them together. Correct representation so that the budget makes sense and is easy to comprehend.
The good old spreadsheet is one of the most common ways to create and display a budget. You can make use of mathematical functions to calculate the numbers and projections quickly over a duration.
You can also make use of readymade templates in Google Sheets. You’ll need to customize the template to your information and fill in the details. Else, you can take inspiration from the template and create a new one from scratch.
Budgeting involves a lot of numbers, calculations, and records. Managing it on sheets can be pretty cumbersome and time-consuming. Budgeting software can make your life much easier.
Budgeting systems have the features to help you plan, forecast, and manage your company’s budget in one place. You can generate financial reports, examine KPIs, track cash flow, and much more.
Accounting and bookkeeping software can also help you a great deal in pulling the actual data and comparing them with your budget.
Creating a budget is essential to keep your business’s financial health in check. Also, a budget presents the opportunity to plan your finances for maximum outcomes.
To create your budget, you need to estimate your income, expenses, and profit and make projections over a duration. An effective budget considers costs and revenues in detail. And, it forecasts based on realistic trends and business goals.
Creating a budget involves presenting the information in a manner that is easy to understand. Spreadsheet and budgeting software can help you with the same.
Finally, regularly reviewing your budget is crucial to reaping the maximum benefits of your budget.
We hope this guide helps you create a robust budget that enables you to steer your business in the right direction. Happy budgeting!