Written by Latasha Barnes, CFO
Budgets are a crucial step in ensuring financial stability and achieving business goals. A well-crafted budget allows a company to allocate resources efficiently, anticipate cash flow needs, and measure financial performance. Ideally, an annual budget is prepared, detailing by month, expected operating revenues, and expenses and capital expenditures.
Here’s a step-by-step guide on how to create a budget:
Step 1: Set Clear Financial Goals
Before diving into the numbers, it’s essential to understand what your company aims to achieve financially. Are you looking to expand operations, launch a new product, or improve profitability? Consider drafting and implementing a three to five-year strategic plan as well. This will inform the financial parameters for your annual budget. Setting clear and measurable financial goals will provide direction and purpose for your budget.
Step 2: Gather Historical Data (History is a good teacher but not always right…)
Review your company’s financial statements from the past few years. Analyze income statements, balance sheets, and cash flow statements. This historical data will serve as a good foundation for building the budget but should not be the sole jumping-off point. In a growing organization, goals change year over year and the budget must adjust as well.
Step 3: Estimate Revenue
Projecting future revenue is one of the most critical parts of budgeting. Use historical sales data, industry trends, and economic indicators to estimate future revenue. If your operations are more local or regionally focused, consider those local or regional market and economic factors. Are there new laws or rules expected in the coming year that may impact your business? Break down revenue projections by product line, service, location, or department for more detailed planning and analysis of operations.
Step 4: Estimate Expenses
Expenses are both fixed costs and variable costs.
Fixed costs remain constant regardless of business activity (start-up costs, rent, administrative salaries, insurance, and loan payments). Variable costs fluctuate with business activity levels (certain other salaries, raw materials, utilities).
List all your fixed costs and ensure they are accurately reflected in your budget – these help you determine the minimum revenue needed to cover these expenses. For variable costs, analyze past spending patterns and correlate these expenses with budgeted production revenues. Remember to account for potential changes in production levels or supplier prices that could impact these costs.
Step 5: Plan for Capital Expenditures
Capital expenditures are investments in long-term assets such as equipment, technology, or facilities. These investments are crucial for growth and efficiency but require careful planning. Review your company’s strategic plan as part of the overall budget process, especially capital planning. Include any planned capital expenditures in your budget and consider their impact on cash flow and long-term financial health.
Step 6: Expect the Unexpected
Unplanned expenses and changes in revenue can occur, so it’s wise to include a contingency fund in your budget. Typically called “Miscellaneous” or “Other” expenses, this category should not be considered a simple catch-all or “plug” to get to the budgeted expenses desired to meet a margin target (or balanced budget, in the case of some not-for-profit organizations). Setting aside a percentage of your budget for unforeseen costs will help your company stay resilient in the face of unexpected challenges.
Step 7: Communicate and Implement
Once your budget is finalized, share it with all relevant stakeholders, including department heads, managers, and employees. Ensure everyone understands their role in adhering to the budget and discuss any implementation concerns. Implementation requires monitoring spending, tracking revenue, and making adjustments as necessary to stay within budgetary constraints.
Step 8: Review and Adjust
Budgets are not just numbers on a spreadsheet. A budget is a dynamic operating tool. Regularly review your budget against actual performance to determine how best to pivot strategically and adjust operations, staying on track to achieve budgeted goals.
Other Considerations
Consistent performance measurement is key to a successful budget and operations. Implementing accounting software to streamline financial transactions and automate bookkeeping makes this process simple. Consider implementing QuickBooks Online, NetSuite, Xero, or FreshBooks, to name a few. Also develop key performance indicators, or KPIs, or perhaps a financial dashboard for quick access and visibility into the financial health of your organization. Monitor these monthly, along with your budget, and adjust as needed.
See below for links to budget templates and other financial resources to help you develop a strong financial foundation for your company.
