Many entrepreneurs find budget management difficult and unnecessary. “What’s important is to earn more, but we’ll figure out how to spend it!”. This approach is very popular. Why waste time on boring and incomprehensible numbers? But only proper budgeting allows the company to achieve its goals and grow faster than its competitors. You only need to take a little time and figure out how to create and maintain a budget.
A budget is an item-by-item plan that includes the company’s income and expenses for a certain period, with the appointment of responsible persons for each item. Most often, it is drawn up for a year, but the company itself can increase or decrease the period for which the budget is calculated. For a small business, precise planning for several years ahead is impossible. But in a large company, it is not advisable to make a budget for a month: it will take a long time to prepare it.
Advantages of budgeting
1. A budget helps you analyze your company’s performance
The planning process forces you to take a step back and look at your business from the outside, which makes it possible to see mistakes. Sometimes in the heat of work, large expenses on rent and advertising are not obvious, and smaller expenses are underestimated. When drawing up and executing a budget, you have to pay attention to these.
Rose Steely, CEO of a communication agency:
“We have a small company – 25 people, we are engaged in comprehensive promotion on social networks.
For a long time, we did not keep financial records – we always made rough estimates of our income and expenses, we tracked only large expenses for our company, we didn’t take small inhouse expenses into account. This resulted in a large overhead that could not be tracked. There was no point in hiring a financier, so we solved the problems on our own.
Last year, we introduced Finiqa cloud in our company, which allows us to automate and structure information from all current accounts and, accordingly, maintain an income and expense budget and a cash flow budget. There we also control the company’s turnover, expenses and their purpose.
Now we can track expenses for each project separately, their marginality and cost price. The results of this analysis help us to clearly assess our effectiveness as a business, see the effectiveness or necessity of each contract, and most importantly-to estimate the real cost of our services, which turned out to be an order of magnitude higher than we previously thought. As a result, we recalculated the cost of agency services and increased the company’s turnover”
2. Capital flows are better controlled when there is a clear understanding of what you need to strive towards
To “Earn a lot” – sounds more like a dream, not a goal. How much is a lot? For what period? What are the ways to achieve this? A budget helps you specify a goal and determine how much money you need to spend in order to achieve it.
3. Having a budget makes you disciplined and allows you avoid unpredictable spending and cash gaps
When you get paid for a big project, it’s tempting to spend the money right away. You think: it would be nice to update some equipment, organize a corporate event, invest in cryptocurrency. But having a budget will not allow you to do this because it clearly states what your planned expenses are.
Jason Kenny, founder of a consulting company:
“Financial planning is a necessary tool for companies of any size. I already have a fairly large consulting company, there are 2 branches in England.
My financial planning model uses both an income and expenditure budget and a cash flow budget at the same time. This helps us manage our finances more accurately. We never plan strategic work with our finances “on the spot”, rather, we plan. We have a budget for a year ahead.
At the same time, managers make a weekly decision on what to spend money on “at the moment”. They consider applications for allocation of funds from all departments. They are guided by the principle of allocating funds for ventures that will bring better results and, consequently, increase the company’s income in the subsequent period”
Disadvantages of keeping a budget
- Drawing up and monitoring budget execution takes time. You can’t create a plan once and copy it from month to month. No matter how stable the company’s work is, there will still be changes.
- A budget can increase the “paper” work load of employees: reports, plans, and explanatory notes.
- The implementation of a budget may cause dissatisfaction among the team members.
Stages of budgeting:
The CFO is usually responsible for creating a budget. Data can be collected “from the ground up”: Each department of the company draws up their own budget, information is collected throughout the company, combined and a total budget is obtained. In this case, the budget is obtained as close as possible to real conditions, but there is a risk of distortion of the initial data. It may be advantageous for business unit managers to underestimate their estimated income or unreasonably inflate their expenses.
The “top-down” approach creates a general budget for the company that meets the goals and strategy of its development, and then “descends” to the departments. The disadvantage of this approach is that it takes a lot of time to compile.
Combined approach: first, the departments draw up their own budgets, then they are combined and adjusted based on the company’s strategy, and then they “go down” again.
Regardless of the approach, budgeting involves the following steps:
1. Demand forecast for the company’s goods or services
The forecast takes into account the occupied niche, seasonality of the products/services, and sales in previous periods. Indicators cannot be taken from the sky, as much as you’d like to.
2. Accounting for variable expenses
The production of one hundred teddy bears requires a certain amount of fabric, accessories, stuffing, packaging. At this stage, you need to evaluate what stocks of materials and products the company has. Maybe you won’t have to produce anything at all, if there’s a batch of a hundred toys already in stock. Or you may need to buy all the material because your inventory is depleted.
Variable expenses also include expenses for delivery, storage, and promotion. Companies that have been keeping records for a long time, for example, in our service, know how much money they need to spend on advertising in order to develop. This indicator can be taken into account when drawing up a financial plan.
3. Accounting for fixed costs
This includes rent of a sewing shop and office space, salaries of administrative and production personnel, communication costs, utilities, depreciation, and more. Usually, these expenses are approximately the same in each period, so they are called fixed.
4. Appointing responsible persons
Someone has to be responsible for every item on the budget. This is the only way it will work to benefit the company.
The income and expenditure budget is a forecast of profits and losses for the upcoming period. It helps you plan your profits, evaluate the profitability and efficiency of your business. How much profit will the production of toys bring? How will it change compared to the previous period? How will the increase in expenses affect your business? An income and expenditure budget will help answer these questions.
Any business can develop a budget structure that suits it, but it is easier and faster to use ready-made solutions.
Cash flow budget – forecast of cash inflows and outflows. It shows how well the company is doing with money, whether it is facing a cash gap, and whether it needs to additional funds.
It consists of three blocks:
- Operating activities – everything that is related to the normal operation of the company: income from the production and sale of goods, provision of services, expenditure on raw materials and labor, taxes, and so on.
- Investment activities: long-term investments, for example, in fixed assets, and income from the sale of assets. If the teddy bear company decides to buy new equipment, the costs will need to be attributed to this block.
- Financial activities: This comprises of loans received and repaid (without their interests), leasing, and investments of founders. The company in our example assigns monthly loan repayments to this stream.
Budget cycle
It consists of three phases: planning, monitoring, and analysis.
The most important part of keeping a budget is planning, and making a mistake here can be costly. But you can’t stop at planning: without completing the next steps, the budget will remain just a project.
At the control stage all expenses and revenues resulting from the company’s work are accurately recorded. The budget period is usually divided into shorter segments, such as a quarter or a month, so that there is a clearer understanding of the indicators that you need to strive toward. This will help you adjust your work if you encounter any problems.
After the budget is completed, the analysis stage begins. It reviews the past period, compares expected and actual indicators, finds out whether it was possible to achieve the set goals, what helped, what prevented them from being achieved, and what factors should be taken into consideration in the next budget.
Then the planning stage begins again: based on the data obtained, a budget for the next period is drawn up.
No matter how difficult it may seem to maintain a budget, just get started. Planning income and expenditure gives an entrepreneur a lot – it is an analysis of the company’s work and an opportunity to objectively evaluate their activities. Two numbers on a piece of paper with a revenue and cost plan are already a budget, if it is based on analysis and it is accepted for execution. Over time, it can grow into a perfectly debugged system that is suitable for the particular company.
