Basic Business Budgeting
- Ketivinne Anrich
- Oct 8, 2023
- 7 min read
Do you know how much your company is spending on an annually, monthly, or even weekly basis? This post will break down all the essential concepts and terms you need to know. If you haven't checked out my episode (S1: E1) on this topic, it will be linked below.
It can be pretty difficult to start a business and make money, especially without being familiar with the concepts, terms, and tools that businesses use. So, what's the first step in cracking that money code and finally planning and making profit? Learning how to budget! An essential element in running a business is understanding what a budget is, how to use them, and how to create them.
Let's get right into budgeting, arguably the backbone of any business.
Table of Contents
Listed below are the concepts that are covered in this blog! Maybe you're already familiar with a few of these concepts. Or maybe you're revisiting for clarification. Perhaps you're new to this post, and you're just checking out what it contains. Whatever it is, just click on a topic to jump to that section of the blog. Happy reading!
What is a Budget?
A budget is an essential document that a business uses to keep track of their financial information, record the flow of their money, and to help CEOs make important business decisions. Every business needs one to compare their performance from year to year, manage their money well, and to help them predict future incomes and expenses. Budgets are tools that help simplify business processes, ensuring that money is spent and gained correctly at the right times.
Common misconceptions about budgets are that they’re just one big spreadsheet, just for writing down how much money is going in and out. Budgets aren't just one spreadsheet, however. Businesses use different types of small budgets at once to properly track all financial flow in every sector of their business. Later, they can also combine small budgets into a larger one to track generalized costs. An example of this is a company having separate budgets for warehouse facilities and office buildings. However, that company may also generalize those two budgets into one, and create an operational budget.
Another big mistake that businesses make in the beginning is not creating a budget or updating it for every transaction since money can also be tracked through bank accounts or other programs. Budgets aren't only helpful for tracking money, but also for organizing where money can go and planning funds for projects!
Different Types of Budget
There are a lot of different types of budgets, going from super specific to pretty general. We'll be covering three pretty general but important budgets that every business should have. The operational budget, the cash flow budget, and the capital budget.
Operating Budgets
·Operating budgets are one of the most foundational budgets that a business can use. They have elements such as revenue, expenses, fixed costs, and variable costs: every financial aspect that outlines operation costs of your business.
Operating budgets are kind of like a collection of budgets: they also contain sales, production, direct materials, direct labor, overhead, and general and administrative expenses budgets.
Operating budgets break down these other budgets and combine it into one budget to determine their goals for the following year.
This means that operating budgets are usually created towards the end of the year, accounting for success, failure, anticipated and actual revenue, and market trends, all to set out a yearly planned budget, and to keep your business in operation.
Cash Flow Budgets
Cash flow itself is an extremely important element in budgeting, as it’s about predicting the money that will come in or out of your business in a certain timeframe, such as a quarter or a year.
Cash flow budgets can help owners make important financial decisions (using cash flow), prevent overspending, and detect issues. The goal of these budgets is to ensure that there is enough money coming in to cover any money going out.
It would be pretty bad if you were spending more than you were gaining, and that is exactly what this budget aims to prevent. If you do spend more than you gain, you would be experiencing negative cash flow.
Capital Budgets
Capital budgets are another essential type of budgets to most organizations. In this day and age, most businesses require or prefer the use of advanced technology, which can be pretty expensive.
Capital budgets help plan for purchases of large assets, like machinery, property, and vehicles. These budgets also give a timeframe of when the business can purchase their asset, expect payback, and the return on investment for the asset.
This budget helps determine whether or not a large purchase for the business would be beneficial.
Master Budgets
Master budgets are budgets that contain a general overview of other budgets. Therefore, the operational, cash flow, and capital budgets would all be listed and added up together in this budget.
How Often Should Budgets Be Reviewed?
·Budgets of businesses should be reviewed at least mid-yearly, but it is recommended to review them quarterly. They should also be reviewed whenever planned budgets overshoot or undershoot the actual price, and can be adjusted accordingly to fit or find different options.
For example, if you wanted to buy an ice-cream machine for your ice-cream business, you would’ve planned on buying the machine at the end of the previous year. 3 months later, you have saved up enough funds to buy the machine, but you realize that the price was raised from when you last checked. Now you have several options: you can review your budget and decide if you want to buy a different machine, you can wait to earn more money to buy the machine, you could pull money from other areas of your budget, or invest the money you’ve raised towards something else.
It depends on the individual business on when budgets should be reviewed and how those reviews are used. Reviewing budgets often help avoid mistakes and accept opportunities for businesses.
What Are the Steps Involved in Preparing a Budget?
1. Understand your organization's goals.
Whenever creating anything, any idea, it’s essential to ask yourself, “What is the goal for this project?” The same goes for budgets! Have a clear understanding of the work you want done in the budget’s timeframe. This will make it a lot easier to create a budget that is more manageable and simpler.
For example, if you have a clothing store that is going to release a clothing line of 15 items, you want a budget for the release of that line. Say that this budget is going to be for 3 months.
For this, you have to account for the manufacturing, marketing, storage, shipping, and the other numerous factors that will affect your budget. You may have to pull money from other parts of your company budget to fund this new clothing line, investing more heavily in the new idea.
2. Estimate your income for the period covered by the budget.
To do this, you need to figure out your income and cash flow for the period of your budget.
In the clothing line example, our budget’s timeframe is 3 months. This means that we need to figure out an estimated number of customers that would buy the new clothing line.
Using past sales data could help with this. This can help the business make decisions on how much of each item to manufacture, store, and how to market those items. Any types of income are welcome though, including donations, investments, and other sales.
3. Identify your expenses.
To do this, you need to understand three elements: fixed costs, variable expenses, and one-time expenses.
Fixed costs remain constant over time and don’t change dramatically, such as rent and subscriptions. They are regular and expected.
Variable expenses change depending on business activities, sales activities, and over time. Shipping and distribution costs, for example, can change depending on demand, commission. Similarly, manufacturing costs can change for the same reason.
By understanding what you need to purchase within these three categories in your budget timeframe can help you understand the minimum amount of money you expect to flow out.
In the scenario of our 3-month new clothing line budget, we could say that we need to spend an X amount of money per month for 3 months on the utility and basic maintenance on the facilities being used for it, which would be our fixed costs. Our social media marketing would also be fixed if we set limits to our marketing.
Variable expenses such as shipping or distribution fees can change depending on the demand of the products form the clothing line, so gas and electricity will be higher during those times. We would predict that by adding in X amount of money, and always adding some buffer money in case predictions were off.
One-time expenses would be if we want to pack orders of this new clothing line with stickers or special boxes. We’d order a certain number of special products at once, and add that fee into our budget.
In total, we would add all of the money for our 3-month expenses together to calculate the total amount of base money we’d predict/need for launching our clothing line.
4. Determine your budget surplus or deficit.
After calculating your income and expenses, you can apply them to the budget and calculate them with each other. If your income covers the expenses with some leftover, you have budget surplus, which is great! You can use this additional money for other purposes, such as funding other parts of the project, placing it in emergency funds, or for the general income of your company budget.
If your expenses are more than your income, you have a budget deficit. You have to figure out how to fix this gap by downsizing on the product: you could try to lower fixed or variable expenses, selling assets, or other methods to work towards a budget surplus.
Tips to Keep in Mind When Preparing Budgets
Some tips to keep in mind when budgeting is to have a clear timeline so that you can meet deadlines and maximize productivity. Time management is key in budgeting!
Budget towards goals, it is great to keep track of company finances in general, but always have new goals in mind. This will boost progression and grow your business. If you’ve reached your goals for a certain time period, control your money as much as possible and start brainstorming bigger goals. Business is strongly rooted in taking risks and trying new things (within reason).
The market, trends, and situations are always changing left and right. No matter how well your predictions have been in the past, there should always be some money left on the side for surprises and emergencies.
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