By: Arlene Meyers
Key Takeaways:
- Business owners should be creating a budget for their companies to serve as a roadmap for the year of business operations.
- A formal budget serves as a foundation for operations and financial decision making, provides guidance and goals, and satisfies requirements from lenders/boards.
- Budgeting should begin now (if on a calendar year basis) or before the start of your fiscal year. Consult with trusted advisors, CFO/controller, and other management staff when constructing a budget.
- Focus on revenue and expense estimates from last year; exclude one-time expenses.
- Variances in the budget provide insight into performance and aid actionable discussions.
As we approach the end of the calendar year, business owners and their finance professionals are deep into the process of creating their 2024 budgets.
Or at least, they should be. But too many small business owners don’t craft an annual budget for their companies, leaving them without a roadmap to help navigate the coming year of business operations. What will happen when the company administrator requests $10,000 to buy new office equipment in February? Or when a strike at a manufacturer that buys your goods results in a sudden drop in revenues in June?
A budget won’t help you avoid unforeseen needs and business downturns. But it will provide a guide and goals that will enable you to make adjustments wisely. If you budgeted $5,000 for new office equipment in February, you have a rationale for telling the administrator to either cut back on the purchases or spread them over several months. And if a drop in revenues is threatened by external forces, your budget will help inform decisions about which expenses to cut and whether you’ll need a short-term loan.
Why Create a Formal Budget?
A formal budget serves as a foundation for your operations and financial decision-making, and also satisfies requirements set by your lender and your board.
Importantly, the budget serves as a guide that can help you remain on a steady course.
Emergencies and adjustments won’t change your budget. Once it is set, the budget document remains static throughout the year. But the monthly budget reconciliation, which shows variances between “budget” and “actual” items, tells the story of your year and illustrates where you may need to trim the sails. So at the end of the year, when you are building the budget for the following year, you have an accurate historical record of what your actual income and expenses were, providing a solid basis for crafting a realistic new budget.
A formal budget also helps you restart the measurement process every year, tracking your company’s performance over time. It allows you to consider events that may be on the horizon for the next year, such as significant purchases, introduction of a new product line or staff expansion, and include those costs in your new budget.
Bear in mind that the budget – since it remains static throughout the year – does not reflect the unexpected events that inevitably happen throughout the year. Those are reflected in the cash flow budget, a child of the budget that contains data on the actual costs and income. The cash flow budget tracks money in/money out and provides the accurate data you need to craft a realistic budget for the following year. Its numbers show up in the “Variances” column on the monthly budget reconciliation.
How to Create a Budget
Get started now. Budgets should be finalized before the start of the new year, assuming your company operates on a calendar year basis. If you are on a fiscal year basis, the budget should be built before the start of your new fiscal year.
If you have never created a budget for your business, working with a trusted advisor is a good practice. Your accountant has helped many other business owners build budgets and can show you the tools available on your digital accounting platform – or even templates available in Excel – that can help guide you through the process. Most platforms include budget capabilities and all the data you need.
Work closely with your CFO or controller. You may be surprised at the analytic data they are able to provide that will result in a more realistic budget.
Before creating your expense estimates, consult with your management staff. Besides your CFO or controller, you also need to hear from human resources, marketing, IT, operations and administration. They will have wish-list items they want to include in the budget, and this may be a good time for you to learn that the office printer is broken and some of your software licenses are out of date.
Once your team is assembled the first step is simple – identify how much revenue you expect to bring in during the next year and when it will come in. Then look at historical expenditures and estimate what you will need to spend money on in the coming year, and when you’ll need to spend it. There may have been some extraordinary, one-time expenses in the previous year that won’t be repeated. You don’t want to include those in your budget.
As you research your income and expenses for the previous year, stay focused on the “actual” numbers each month. There is no reason to look at the cash flow statement or the balance sheet at this time; they provide no relevant information needed for building a budget. Likewise, your company’s level of debt is irrelevant to the budgeting process, except for including the cost of interest payments as an expense.
A Budget Roadmap
The process of creating your first budget may be time consuming and possibly frustrating. But once it is done, you will have a document that will help guide discussions and decisions in your company over the ensuing year. If your actual revenues turn out to be lower and your expenses higher than the budget, it may highlight deficiencies in your processes. Budget variances can highlight the good and the bad, and they always provide important insight and facilitate actionable discussion.
If you would like to discuss starting a budget process for your company, contact your KRD advisor.
