If you own a business, budgeting is its central nervous system. But this isn’t an easy exercise. Using a budget is a key component in driving your organization’s financial future, but many businesses wonder: “How do we start?” or “How can we make our current budget better?”
Because a good budget will have a great impact on your overall operations, here are 10 tips to help your business build an effective one.
Tip 1: Understand What a Budget Really Is
A budget is not meant to manage every penny spent. It is simply a guide to assist you in making better spending decisions, and it can be an eye-opening tool to identify areas for improvement.
When creating a budget, it’s important to maintain the right mindset. If you harbor a negative attitude about budgeting from the outset, the chances of creating a good budget significantly diminish. Instead of seeing it as a hurdle, consider creating a budget a positive move that provides you with a helpful business tool.
There are also different types of budgets. Some companies find it beneficial to budget on the accrual basis to estimate net income, while other companies focus on budgeting for cash flow.
Some companies have two budgets to track both of these key financial performance measures. Regardless of which budget type you choose, everyone in your organization needs to be on the same page when it comes to the budget’s goals.
Tip 2: Know Your Company — Know your Business
It is important to understand the risks of your business and its industry. For example, if you operate in an industry that is significantly seasonal in nature, you will likely need to break down an annual budget into a quarterly, or even monthly, approach.
Before diving into the creation of your budget, you should be aware of pending changes in regulations, such as new payroll rules, health care, new tax laws etc.. You should also compare your business to industry standards something your CPA has resources for. Obviously, your business is not exactly like every other one in your industry, but if you can identify areas where your results vary significantly (and the reasons for those variations), you can make better decisions about spending.
Overall, it’s a good idea to identify the most substantial threats to productivity within your organization and their financial impact. Know your competition.
Tip 3: Build the Right Budget
“If you build it, it will come together.” Okay, not quite the same line Kevin Costner’s character took to heart in “Field of Dreams,” but it’s very important use the right resources to create your budget. If you are a sole proprietor you need to havfe someone hold you accountable to your budget. ( bookkeeper, spouse, partners etc.)
Maybe it’s time to think outside of the box and involve other individuals who can bring fresh perspectives to the budgeting table. For example, an employee may be able to identify when equipment will need to be replaced or overhauled. And who better to predict when potential repairs to delivery vehicles might be necessary than those who drive the delivery vehicles every day?
Tip 4: Be Realistic
A budget isn’t truly effective if it’s designed toward a targeted number.
You should develop your budget based on past results and future projections. Analyze financial results from up to five years ago as a starting point. What are some costs that are fixed and inevitable? Those can be entered first. Then you can look at accounts or items that have fluctuated more drastically over the years. What caused this fluctuation? Were there one-time expenses? Can these fluctuations be controlled? Using past information and adjusting for predicted variances helps provide a more concrete basis for establishing budget numbers.
Tip 5: Be Conservative
As part of your budget, you should factor in some level of the unknown. “You don’t know what you don’t know, but you know that you don’t know something.” In other words, there is always some unexpected elements that will cost you money. If we knew all of a businesses anticipated costs and factors we wouldn’t need a budget..
Should you have a line item in your budget for unknowns. One way might be to round up each individual line item to factor this in? It’s up to you how you factor in unknown elements.
Make sure you consider the need to plan for future years. Economic downturns are inevitable, so in a strong economic year you should not only create a balanced budget but also start building up a cushion for the anticipated rainy days.
Tip 6: Be Flexible
It’s okay to amend your budget during the year; in fact, it should be amended several times throughout it. Revisiting your budget is a very healthy exercise for your business’s well-being. If you wait until the end of the year to compare your actual results to the budget, you will be way behind the curve and more than likely your budget will not produce you any results.
Tip 7: Be Detailed
The more detailed your line items (expenses, income etc.) are, the more effective your budget will be. Now, there is a fine line here. Obviously, you don’t want to have a separate line item for each check you write, but the more detailed you can get, the better. And that starts with tracking expenses according to the way your chart of accounts is set up. Use this detail to knbow what is going on with your business at all times (example track your meals and entertainment expenses are they accurate, how about those office supplies are they reasonable business purchases do you have receipts for what you purchase).
For example, some businesses may be fine with a line item called “payroll.” But other organizations will want to break that down by division or employee position type. Similarly, instead of having a line item for “employee benefits,” it may be more beneficial to have a line item for each type of employee benefit (e.g., health insurance, retirement benefits, sick and vacation pay and tuition reimbursement).
When it comes time to analyze why some line items were out of whack compared to the budget, this can help ease the pain.
Tip 8: Be Aware of Financial Relationships
Sometimes you can’t change just one line item in your budget. It’s like going to the store and buying a flashlight. You have to pick up batteries, too, right?
As a result, sometimes you have to be careful changing one line item of your budget without analyzing that change’s effect on other line items. For example, if you find out that you are going to increase your workforce by 10%, instead of simply increasing the payroll line item by 10%, you will want to increase employee benefits, payroll taxes and other items directly related to payroll.
Similarly, if you think you can just bump up your bottom line by increasing sales by 10%, don’t forget to also increase all the other costs related to sales (e.g., costs of goods sold, commissions, taxes and freight).
Tip 9: Utilize the Right Tools
Most accounting software has a built-in budgeting tool, so if you’re frustrated get help take a step back and look to the new year as a goal to start fresh with a working budget. There are so many easy ways to create and maintain a budget. Do your homework and do what is best for you and your business. What works for someone else may not work for you,
Setting up a budget make take some time initially but increased efficiency and less financial stress is well worth it. Once you get started you can link your results to multiple prior years and analyze the current-year budget with a simple click of a button. Let your software work for you!
Remember it is your business, your money and you need to know where it is going. Be smart.
Tip 10: Just Do It
The more information you gather in your budget set up will allow you a greater understanding of where your money is going. You will be in control of your income and know how to prepare for the future whether that future is next week or next year. A good budget has a huge impact and is a tool every business should utilize.
“The simplest definition of a budget is “telling your money where to go.”