Calm down, it's just a little accounting humor...there are no debit or credits you need to worry about when building a budget. It's actually a semi-simple process, depending upon what type of business you have, to develop a budget that will help guide your business.
In this blog, I am going to explain some simple strategies on how to build a budget for your business, how to measure it against actuals, and how to use the information to help make decisions for your business. Yes, you could take the one principle from this information, have a positive amount leftover, and implement it into your personal budget, but really this is meant for someone that owns a business and wants to understand how to put together a simple budget, stick to it, and create a positive net gain as a result.
Building a Budget
The revenue that your business makes, tends to be the hardest to budget as there are more variables that will affect the outcome of how much income you bring in the door. Therefore, depending upon what type of business you have, I want you to really try to understand what affects your revenue and how it can be improved. That will help you create a budget that is much more accurate.
In general, I like to use the prior year's results to build the forecasted revenue. Since I am usually building out the budget in November, I use numbers through October of the current year and use the prior year's November and December to forecast what the current year's November and December would be. This brings me to a full year of actual plus 2 months' of forecasted revenue to work from. Note that you may have to adjust your forecasted November and December based on what is happening economically in the current year.
To explain this process better, let's use the above pictured example of a retail store's 2023 budget. I researched what experts believe the percentage growth or shrinkage we can expect in overall sales for our specific company. The research should be as specific as possible as retail sales trends vary greatly. But in this specific model, the research pointed to a 6% growth rate.
The next step is to take the prior years' monthly results and overlay a 6% increase on each month. Most retail is seasonal which is why we want to follow past trends in terms of which months have the highest sales and which have the lowest. Remember, we need to manage cash flow also and a budget helps us do that in the down months. The result is a full year of forecasted revenue.
There are two types of expenses that we need to budget for; variable and fixed costs.
Variable expenses are costs that fluctuate with the company's output such as; electrical, labor, COGS, etc. Fixed costs are monthly costs that tend to stay at a flat rate and are easier to forecast.
When I budget variable costs, I use the prior year's or year to date's percentage of revenue for a specific cost. Refer to the budget above in the COGS section and notice to the right of the budget are my percentages that I used to calculate the forecasted expenses. In this example, the "Supplies & Materials - COGS" percentage has been running at 31.45% of revenue. The next step is to fill in the expense lines using the variable percentage multiplied by that month's revenue. Note that, depending upon your strategy, these variable percentages do not have to be based on the past. For example, let's say you are implementing a new buying strategy at the beginning of the year and you anticipate some kind of margin increase. With this information, we are going to adjust the percentage down from 31.45% to something reasonably less. As the months roll on, we start to see the true savings this strategy created and can now forecast based on this new information.
Fixed costs are much easier to forecast because they are usually a flat amount. What can be tricky is determining increases due to outside factors like inflation. The inflation that we have experienced over the last year or more killed a lot of budgets out there! Point being, you need to determine if the fixed cost will increase, stay the same, or decrease. As you see in the budget example, I also have my percentage change on the fixed cost items.
Keep in mind that these percentage changes may not just be inflation. For example, let's say you want to increase your revenue by advertising more. You will have to determine what your percentage increase will be to ensure you include enough funds to put the strategy in place and then put in metrics to understand if the advertising strategy is actually working.
The final step of building a budget is looking at your strategy as a whole, for the upcoming year, to determine what effects it may have on the budget you just created. Are you looking at expanding? If so, what does that look like in your property expense part of the budget? How much revenue will that drive? Planning is the key to success so having a good understanding of where you want to go, is important.
Measuring the Budget
Nowadays, it is very easy to measure how you are doing against your budget due to the fantastic software and other budget tools that we have available to us. QuickBooks, hands down the best accounting software, makes it very easy to create the analysis.
Assuming you are using QuickBooks
Online, click "Budgets" on the left hand side. There you can add a new budget and load the forecasted numbers in to the budgeting tool. Once this template is loaded and balances to your budget that you created, you can now measure your actual results versus your budgeted numbers.
Next step is to go to "Reports" and search for the "Budget Versus Actuals" report. Mark it as a favorite and any time that you want to see how you are doing, you simply click on that report and put the date range in that you wish to look at. Make sure you have downloaded all your banking activity and categorized the transactions accordingly to ensure that your report is up to date.
Using Budget Information to Drive Your Business
Cost mitigation and revenue generation are your key objectives when building a business. What your Budget Versus Actuals report does is show you where you are out of balance with your budget. This may be a result of a few things such as lower sales or ungodly inflation, but the main point is to find your problem areas and adjust accordingly.
I need to warn you on the cost savings part...do NOT cut expenses that directly affect your revenue. I have seen this time and again where companies continue to try and increase their profit margin by decreasing expenses that are producing the revenue. They are slitting their own throats.
From a revenue standpoint, let's say that your sales are not meeting expectations. Is the economy behaving differently? Is my product life cycle changing? Or, are there things that you can control to increase product sales? Based on the information that is derived from creating a budget, you now have indicators that can help steer the business in the direction you want it to go.
I hope this article gave you some simple methods on creating a budget on your own. The other result may be that you are even more overwhelmed than you were before you read this! Oops.
If so, and you are a business owner that needs help understanding how to create an accounting environment that will open your eyes further in to your business, you may want to look into a Remote Fractional Accounting option. The value that you receive for your business will outweigh the cost of implementing someone that can run all your financial analysis. If you would like to learn more about how we can work together, please use my contact page.
Blue Collar CFO