- Don't over-exaggerate estimated revenue and profit
- Don’t forget taxes, including: sales taxes, state and federal taxes
- Don’t forget seasonality – business could be going great one month and slow the next
The budgeting process for smart, modern companies
The budgeting process can be long and difficult. There are questions to answer, riddles to solve, and teams to consult. As a result, budgets can easily be left until it’s too late, or not done at all.
And on the other hand, you have the overly prescriptive, downright pedantic budgets. Those that have every tiny expense accounted for, managed across a suite of spreadsheets that most users can’t understand. This is definitely better than no budget at all, but can create plenty of trouble along the way.
Whichever side you land on, this article will help. It sets out the essentials of the business budgeting process, to make sure you’re doing what’s required.
It also includes best practices and principles to ensure you’re getting it right, no matter how simple or complex your budget ends up being.
Because your company must have a budget. But it’s up to you whether it’s effective, worthwhile, or simply a big waste of time.
The budgeting process
The budgeting process lets an organization plan and prepare its budgets for a set period. It involves reviewing past budgets, identifying and forecasting revenue for the coming period, and assigning amounts to spend on a company’s various costs.
When done well, the process involves input from senior management, your finance team, and budget managers across the organization.
Think of your budget as putting your business plan into action. You’ve set priorities and goals for the company in the coming year, and the budget allocates financial resources to achieving these.
The importance of business budgeting
At their most basic, the benefits of budgeting are fairly obvious: if the business runs out of money, the business can’t survive. So a clear cash flow plan that all teams can follow is essential.
But beyond simply ensuring the business sustains, there are several great reasons to cherish your budgeting process:
It helps to set clear targets and expectations. Your budget sets targets for costs and revenues, which helps other teams tailor their work to achieve them.
It’s vital for funding. If you’re asking venture capital firms or a bank for more money, they’re going to want to know how you’ll spend it. They’ll also want to see that you’ve made and followed budgets in the past.
It sets out your priorities tangibly. It’s likely that your teams set their own deadlines and timeframes to a certain extent. The budget gives them global guidelines for this, and involving them in the budgeting process makes this possible earlier.
It avoids difficult conversations. Individuals will always have exciting ideas and campaigns they want to run. While this should be encouraged, your budget gives you firm numbers to keep expectations in check.
It connects finance teams with the rest of the business. This is an integrated process that requires input from all over the company. Finance will learn more about other teams’ priorities, and then can offer structured guidance.
Clearly, the biggest upside is that budgets give companies more control and visibility over spending.
8 key budgeting process steps
There is probably no one “right way” to create a business budget. But to guide you through the process, here are eight important steps to follow:
Review the previous period
Calculate existing revenue
Set out fixed costs
List variable costs
Forecast extra spending
Scrutinize cash flow
Make business decisions
Communicate it clearly
Let’s take a closer look at each in turn.
1. Review the previous period
The starting point should always be to look over the existing information you have to hand. And in this case, the best evidence for how your new budget should play out is the previous one.
A few questions to consider:
Did you spend more or less than anticipated?
Were your assumptions about the industry and your own growth accurate?
Were there unexpected hurdles or shortfalls, and what caused these?
Was the budget easy to enforce? Did team members follow it?
You should do this at a high level for the entire company, and you should also encourage individual budget managers (if you have them) to do the same for their own scopes.
Also critical in this step is to consult other team leaders. As we’ll see, the best budgets are collaborative, and you need to know how well the previous budget worked for everyone affected.
2. Calculate existing revenue
The most obvious starting point for any budgeting exercise is to figure out how much you have to spend. This will involve other costs, of course, but we’ll come to these next.
At the company level, you need to identify income streams. How much money are you making gross? List your core products, their pricing, and the expected volumes for each in the coming year. Naturally, this involves some estimates and won’t be perfect.
For startups that aren’t yet profitable (or don’t have paying customers at all), you’ll be spending investor capital or venture debt. So for this stage, you need to identify the “burn rate” you’re comfortable with - how much of the total investment you’re able to commit for each period of time.
3. Set out fixed costs
Fixed costs - often called “overheads” - are those over which you have little control. Most importantly, they’re not impacted by your sales - whether the business succeeds or not won’t have any effect on the amount you pay.
Fixed costs can include:
Rent or mortgage payments for office space
Website hosting and servers
Interest on loans
Utilities (Such as electricity and internet)
Assuming you know your employee headcount for the year, and have your office space and insurance sorted, you can comfortably plan for these costs.
4. Add variable costs
Variable costs are usually thought of as discretionary expenses. As opposed to fixed costs, these are more fluid and can be tinkered with.
Examples of discretionary expenses include:
Marketing and advertising
Corporate investments and donations
Software subscriptions, particularly where they aren’t critical to running the business
Travel and client meetings
Office decor and renovations
“Discretionary” doesn’t mean that these costs are frivolous or unnecessary. A business won’t grow without marketing, and team perks can be a key contributor to keeping employees happy for longer.
But when building a business budget, these costs have to be justified more critically. And when you’re in danger of going over budget, variable costs are usually the first to be cut.
5. Forecast additional spending
Are there any one-off expenses on the horizon? These can include a serious merger or acquisition, consultant help to prepare for audit, or even a special event or party that doesn’t come around often.
If possible, try to set out these irregular expenses separately in your budget. You certainly need to account for them in your spending, but they won’t be a core piece for years to come.
You might also consider a “rainy day fund.” Because the only certainty is uncertainty, it pays to have some portion of your budget set aside in case unexpected events occur and you need a safety net.
6. Scrutinize cash flow
This is where the budget analysis starts. You should now have a clear record of expected revenue and expenses, and hopefully you even have a record of these for the previous period.
Was your spending as expected? Did you have consistent revenue across the last year, or can you spot seasonal effects?
“Cash flow” refers to the relationship between money coming in and going out. You want to know that you’re spending money you’ve budgeted for, and that income dips you can update your expenses to match.
Look for clear indicators that certain parts of your budget might need extra attention. You want to know the particular aspects of your business that impact the budget most heavily, and be prepared to adjust accordingly.
7. Make business decisions
Naturally, you now need to use all of the analysis and preparation you’ve done. And that means forming a clear spending plan for the future. Google Sheets has a great annual budget template, and The Balance has this very simple one.
Of course, the hardest part of the whole process is deciding which projects or priorities get funding, and which don’t. This can be stressful, and we’ve included some best practices below to help. Most important is to try to remain consultative throughout - gather input and rely on the expertise of your skilled team members to guide you.
You’ll almost certainly make updates and changes throughout the year, so it’s important to rely on the data you have today, and to not get too bogged down.
8. Communicate it clearly
The final step is to share the budget with your teams and make sure they know what’s required of them. Chances are you’ll rely on many team leads to handle their own costs, and they need to have the tools and expectations to do this well.
Does everyone involved know how much they’re allowed to spend, and on what? And do they also know how to report their spending as they go?
If you can’t answer “yes” to both of those, you’ll likely struggle to adequately track and measure the effectiveness of your budget.
And then there’s the messaging. For many governments, “budget day” is the biggest day of the year. There’s a reason why political leaders take the messaging so seriously. And while you don’t need to go overboard, it makes sense to get your communication right too.
Business budgeting best practices
Now that we’ve set out the process, let’s also consider some principles to apply along the way. Here are a few excellent suggestions from around the web.
SCORE - Think assumptions before numbers
Obviously, your budget will be full of numbers and figures. But it’s often a great idea to start by clearly setting out what the budget is based on, built for, and how it should be interpreted.
Hal Shelton writes, “When you picture a budget, you likely see spreadsheets with many numbers. But more important than the numbers are the assumptions that drive the calculations.
“Therefore, the first page of your budget should be these assumptions — what products/services are being sold at what prices and volumes, and what the key drivers are for expenses, like the number of staff and locations, various marketing initiatives, etc.
“In essence, you have both an operations and finance budget, and the two are closely intertwined.”
TempCFO - Consider your KPIs
It’s vital that your budget - especially the variable costs sections - reflect the overall goals of the company. So make an effort to tie expenditure back to those priorities, and track your progress as the budget rolls out.
“Key Performance Indicators (KPIs) can point you in the right direction when setting a budget. KPIs can help you plan the smaller details while simultaneously focusing on the big picture. The challenge is to determine what KPIs need to considered.
“Common KPIs for setting a budget plan often include:
Operating cash flow and expenses
Sales and marketing initiatives
Return on equity
Accounts payable and receivable
Just make sure that your KPIs are clear and can easily be measured.
Grasshopper - Avoid these three “don’t”s
It’s always good to have a few areas to watch out for. And even though you may already have these three factors in mind, they’re definitely worth repeating:
These are classics for a reason.
Creately - Revisit regularly
A budget is definitely not “set it and forget it.” In fact, you need to check back, analyze, and update your spending as the year progresses.
“That’s why you should schedule budget reviews from time to time. I recommend starting with reviewing it every month and then switching to a more comfortable schedule. Every month review can help you notice the flaws of your plan (which is especially important if you don’t have much experience in this kind of thing) as well as understand how stable your business is.
“If you see that you don’t have to make changes often, you could start reviewing your plan every three or six months.”
You might even find that you have more available funds than you’d anticipated. And you need to need to know that early, while there’s still something you can do about it.
Business budgets go hand-in-hand with spend management
At this point, you know the ins and outs of effective business budgeting. The next step is actually using it for more effective company spend management. Consider the following:
How will you easily monitor where each payment goes?
Do team members have to manually update a spreadsheet to keep track?
Who has approval for specific payments, and do teams understand these rules?
Chances are, the answers aren’t entirely clear. And many businesses rely on manual processes and diligent employees to stay on top of costs.
Instead, look into good spend management tools. These apply your budgets to your spending methods. So you can have debit cards with limits that match the budget, and workflows that keep the appropriate budget manager in control of each payment.
Most importantly, every payment is logged, so you don’t have to keep Excel sheets up to date. This is company spending for finance teams that need control without being overbearing.
In short, it’s smarter company spending.