Many entrepreneurs find budgeting difficult and unnecessary. “The main thing is to make more money, and we’ll figure out how to spend it!” This approach is popular. Why waste time on boring and incomprehensible numbers? But the right budgeting allows the company to reach its goals and grow faster than competitors. All it takes is a little time to figure out how to make and where to keep a budget.
A budget is an itemized plan that includes the company’s income and expenses for a certain period, with an assignment of responsibility for each item. Most often it is prepared for a year, but the company itself can increase or decrease the period for which the budget is calculated. For a small online casino or a new massage salon, precise planning for several years ahead is impossible. And in a large Netflix or Amazon, drawing up a budget for a month is impractical: more time will be spent on its preparation.
Pros of Budgeting
Budgeting Helps Analyze the Company’s Work
The planning process forces you to step back and look at your business from the outside, which gives you the opportunity to see mistakes. Sometimes in the current operation, large expenses for rent, advertising, and underestimating small expenses are not obvious. You have to pay attention to these points when drawing up and executing the budget.
Financial Flows Are Better Controlled When There Is a Clear Understanding
“Make a lot” sounds like a dream, not a goal. How much is a lot? Over what period? What are the ways to achieve it? A budget helps you to specify a goal and determine how much you need to spend to achieve it.
Keeping a Budget Disciplines, Avoids Unpredictable Spending and Cash Gaps
When payment for a big project comes in, there is a temptation to spend it right away. Here, it would be nice to upgrade the equipment, have a corporate party, and invest in cryptocurrency. But the budget will not let you do this: it clearly states what expenses are planned.
Cons of Budgeting
- Budgeting and monitoring takes time. You can’t make a plan once and copy it from month to month. No matter how stable the company is, there will still be changes.
- A budget can add “paperwork” to employees: reports, plans, explanatory notes.
- Implementing a budget can cause team dissatisfaction.
Stages of Budgeting
Budgeting is usually the responsibility of the CFO. Data can be collected from the bottom up. Divisions of the company make their own budgets, the information is gathered throughout the company, combined and a total budget is obtained. In this case, the budget is as close to reality as possible, but there is a risk of distorting the original data. It can be profitable for the heads of departments to underestimate the estimated income or unreasonably overestimate expenses.
The top-down approach generates a general budget for the company that meets the goals and strategy of its development, and then “descends” to divisions. The disadvantage of this approach is that it takes a long time to prepare.
Combined approach: first, departments form their own budgets, then they are combined and adjusted depending on the company’s strategy, and then they are “sent down” again.
Regardless of the approach, the formation of the budget includes the following stages:
1. Forecasting Demand for the Company’s Goods or Services
Forecasting takes into account the niche occupied, seasonality, sales in previous periods. Indicators cannot be taken from the ceiling. If on average you sell a hundred teddy bears for a hundred thousand rubles a month, you shouldn’t plan on selling ten million. No matter how much you don’t want to.
2. Considering Variable Costs
The production of a hundred bears requires a certain amount of fabric, fittings, padding, and packaging. At this point, you need to estimate what inventory of materials and products the company has. You may not have to produce anything at all – a batch of a hundred toys is already in stock. Or you need to buy all the fabrics because stocks are depleted.
3. Accounting for Fixed Costs
This includes a sewing room and office rent, wages of administrative and production personnel, communication costs, utilities, depreciation and other costs. Usually these costs are about the same in each period, so they are called fixed.
4. Assigning Responsibilities
Each line item in the budget should have someone in charge. This is the only way it works for the good of the company.
An income and expense budget is a forecast of profits and losses for a future period. It helps to plan profits, assess the profitability and efficiency of the business. How much profit will toy production make? How will it change from the previous period? How will an increase in expenses affect the business? A budget of income and expenses will help to answer these questions.
A cash flow budget is a forecast of cash inflows and outflows. It shows to what extent the company is provided with money, whether it is in danger of a cash gap, whether it needs to attract extra funds.
The Budget Cycle
The budget cycle consists of three phases: planning, control, and analysis.
The most important part of budgeting is planning, and a mistake here can be costly. But you can’t stop at planning: without the next steps, the budget is just a project.
At the control stage, all costs and revenues resulting from the company’s work are accurately recorded. The budget period is usually broken down into shorter segments, such as a quarter or month, so that there is a clearer understanding of the indicators to strive for. This will help to adjust the work if any problems arise.
After the budget is implemented, the analysis stage begins. The past period is reviewed, the planned and actual indicators are compared, and it is found out whether the goals were achieved, what helped, what hindered, and what factors need to be taken into account in the next budget.
Then the planning stage begins again. Based on the data obtained, the budget for the next period is formed.
As complicated as budgeting may seem, it’s easy enough to get started. Planning revenues and expenses gives the entrepreneur a great deal – it is an analysis of the company’s work and an opportunity to objectively assess its activities. Two numbers on a piece of paper with a plan for revenues and expenses is already a budget, if it is based on analysis and accepted for execution. Over time, it can grow into a perfectly fine-tuned system suitable for a particular company.