Budgeting Basics

By: The Vanilla Team | Download PDF

Let’s start by pointing out the obvious: It’s not imperative for every company to have a budget. In fact, many successful businesses run just fine without one. However, budgeting is an important tool to consider if your company is growing and you’re looking for ways to formalize and improve your financial management.

Why Start Budgeting?

If your business is growing, then you may soon reach the day when you need a budget (to apply for a bank loan, buy new equipment, raise capital, etc.). After all, nobody is going to invest in your business unless you have a thoughtful set of projections.

In addition, a budget will help you systemize the way you run the financial side of your business. One of the keys to improving profitability is to set targets and then monitor your company’s progress towards those goals on a regular basis. That, in a nutshell, is what budgeting is all about.

For smaller companies, the budgeting process can be boiled down to three basic steps:

Step One: Look at your financial history.

Gather your financial results for the past two or three years and use them as a starting point. Unless you are launching a new business (in which case there is nothing to review), this data will provide the best indication of what’s going to happen next year.

Step Two: Develop reasonable assumptions.

After reviewing your historical data, make a few educated guesses about the future. Don’t worry about crunching numbers yet – just start by answering a few basic questions: “Is the market for your products or services increasing? What do you think your sales growth will be next year? How effective will your marketing efforts be?”

Most business owners have a strong sense of intuition about these things. Trust your instincts and try not to overanalyze.

Step Three: Forecast your expected revenues and expenses.

This takes a little time, but it’s really not as tough as it sounds. These days, most accounting software (including QuickBooks) has a budgeting function built right in – you just have to learn how to use it. The goal here is to use your historical data and assumptions (steps one and two) to build a realistic set of projections.

The end result: a budgeted income statement that forecasts your operating results for the coming year.

Tips for Successful Budgeting

Limit your budget to a twelve-month time span. It’s difficult enough to predict what’s going to happen in the coming year – anything beyond that is unreliable and probably a waste of your time.
Consider two revenue forecasts: a conservative one and an aggressive one. If you’re like most entrepreneurs, you’ll constantly fluctuate between a conservative reality and an optimistic dream state that keeps you motivated and helps you inspire others. Don’t ignore the aggressive scenario. As the old saying goes, “You won’t get bigger unless you think bigger.”
Remember that the budget itself has no value unless you use it. After you’ve prepared your budget, don’t bury it at the bottom of a desk drawer. Take it out and use it on a regular basis to compare actual vs. expected results. A quarterly or semi-annual review is enough for most small companies. The central questions should always be: “Where are we now? And what do we have to do to get to where we want to be at the end of the year?”