Budgeting Essentials in 8 Steps
Accurate budgeting, expense tracking, and efficient reporting of this data are always important to business success. A good accounting system must provide the ability to budget and then track business expenditures by categories and time frames that work best for the business (monthly, quarterly, annually, etc.). Here are 8 steps to an effective budget:
- Set up budget time periods – usually by month with an annual total.
- Determine which expense categories to budget, focusing on the categories with larger expenditures (i.e., don’t get bogged down trying to budget every minor expense category). Keep the budget as simple as possible. Complicated budgets tend to be ignored and are therefore of little use. However, a budget with too many broad brush numbers will add little value when trying to determine what was included in a particular budget line item.
- Add a catch-all category (or use the Misc. category) for combining expenditures in all minor categories. Note that categories may change over budget cycles. For example, Marketing Expense may include a budget for sponsorships, website upgrades, golf tournaments, promo items, etc., but also have a budgeted amount for miscellaneous – e.g., with $250/mo. in it. This saves having a line item for each recipient of $100 or less that was an “impulse” decision or just not a major expenditure.
- As a baseline, utilize historical actual expenditures by the defined time period for each budgeted category, then adjust the budgeted amount for known or expected changes over the budgeted periods – rent increases, insurance renewals, new salaries, etc.
- Be observant of seasonal trends in expenditures – while rent / lease payments will most likely be consistent throughout the year, other expenses may vary significantly by month. Consider the electric and natural gas cycle, most gas bills are minimal in July and August while they peak in January and February. Electric tends to be the inverse of this curve while never dropping as much as natural gas.
- Set up variance thresholds by time period (e.g., per month) for each category, which will trigger management review and action. The thresholds can be by percentage (e.g., 12%) or amount ($). For example, if the threshold is 12% per year, then the monthly variance should be no more than 1% per month.
- Review the budget with management, make any adjustments and finalize budget numbers in the accounting system. Inputting the budget into a quality accounting system allows for budget vs. actual reporting which makes these comparisons and variance analysis much easier.
- Set up a budget notebook or spreadsheet to track comments and notes during each budget time period and for the entire budget process. These notes are helpful to track changes during the budget and to set up the budget for the following year.
Businesses need to develop, implement, and review the expense budget process in the context of business revenues and operations. As part of the budget process, management should develop both a contingency management plan for positive or negative changes in revenues and a crisis management plan for unforeseen events that affect business. (For more information about contingency and crisis management, please see How to Weather Unforeseen Events.)
After the budget, now what?
Monitoring the budget on a regular basis is a clear picture of the financial health of the company. Four benefits of using the budget as a helpful tool:
- Set aside money to use for capital improvements or business investments.
- Anticipate financial requirements for cash flow.
- Understand income, expenses, and profits in real time.
- Prove success for attracting investors or applying for a business loan for expansion.
Many business owners avoid the budget process because they don’t have financial experience or they are too busy running daily operations. Or, they take last year’s numbers, add a growth percentage, and divide by 12. While better than nothing, it’s really not that helpful. Rather than adopting this rote approach, successful businesses use the budgeting process as an opportunity to think deeply about the projected demand for their products and services, anticipated increases in expenses, strategic referral partners, business growth goals, and much more. If the budgeting process sounds like a daunting task, consider seeking advice from financial professionals who can work with existing software or make recommendations for the accounting software that is the best fit for the business.