The Importance of Budgeting

A friend of mine who is starting a business asked me what to do to not fail. There are many things she needs to have in place in order to succeed. Things like having the right target market, the right product or service, being able to deliver that product or service, great customer service, and an efficient back office. However, I believe that making a budget is an essential exercise to avoid failure. Maybe not succeed, but avoid failure.

Here are six reasons for creating a business budget:

1. Provides you a framework

Creating a budget provides a framework to the business leader. When building the budget, one must imagine all the processes in the business and pinpoint where money will be spent and received. This helps you identify key drivers and helps you set targets.

2. Forecast revenues

A key item of a budget is the sales forecast. This is as much of an art as it is science. There are many ways to forecast sales. The two main approaches are top down and bottom up forecasting. Bottom up (role up) forecast is where each member of the sales team provides his or her forecast, from the field, and the numbers are summed up. The top down is based on a macro view of the business. The drivers are more economic driven, i.e. interest rates, GDP, growth of the industry, growth in number of competitors, etc. It is usually suggested to be conservative with sales forecast. Usually, the top down estimates are used to check the bottom up ones. Usually, the sales teams are overly optimistic. Top down and bottoms up forecasts should be in the same order of magnitude.

3. Controls spending

The budget (annually and quarterly) is important in establishing spending controls in any size business. Unless the environment or business strategy has drastically changed, your costs should be within the budgets parameters. If your costs are not within the budget, it indicates that something is wrong. If your costs are too high, there might be employee stealing or mismanagement. If costs are too low, you might be underinvesting which will impact the future growth of the business.

4. Provides a profit margin

Staying within your budget provides you a profit margin. When you have a good idea of your revenues and can control your costs, you are guaranteed a profit. If not you shouldn’t be in business. Of course non-profit organizations will budget with the goal to break even. However, non-profits measure other type of results and should use the budget process to measure their efficiency and effectiveness.

5. Helps communicate priorities

By having a budget you can communicate with employees and partners the priorities. For example, if expanding internationally is a priority, then there should be funds allocated to opening a new office offshore. If customer service is important, there should be an allocation to training and development.

6. It gives you a score card to beat

Monitoring the business against the budget (monthly, quarterly and annually) gives you a target to beat. The budget is the dashboard or score card that tells if your business is performing above or below expectations. If you make $1MM in profits in the quarter but were expecting $2MM you are underperforming, but if you were expecting $0.5MM you are exceeding expectations. The budget gives you that target to shoot for.

Here are the steps to budgeting

· Have a strategic plan (multi-year)

· Set annual business goals (to support the strategic plan)

· Forecast revenues

· Forecast fixed costs

· Forecast variable cost

· Forecast profit

· Approve and commit to the budget

· Monitor and review

· Deal with variances

We’ll review the steps to building a budget in detail in a future post. Please post any comments or questions to the comment section of the blog.

Thanks for reading.

Please note: I reserve the right to delete comments that are offensive or off-topic.