When you hear the words budget, forecasts, or projections, you may see numbers flashing through your head, papers piling up, or formulas dancing in an electronic spreadsheet.
In fact, creating a budget may involve all of these. The concept of budgeting is very simple. Think about it: you’ve been budgeting money your whole life. Your first experience with budgeting was probably as a child when you planned a way to save enough money to buy your first bicycle or video game system.
Of course, as you prepare to start a business, the budgeting stakes are just a bit higher — and, as a result, can be overwhelming. Take a deep breath as we re-visit the basics.
A budget is an estimate of future numbers based on information you already know. Budgets estimate the profits, financial performance and cash flow of a business for a particular period of time. Having and using a budget can help you:
- Evaluate operational efficiency
- Monitor the financial health of your business
- Assess managerial decisions
- Plan the business’s financial future
- Create a business that meets your financial goals
The business planning process begins with budgets because every decision you make throughout this process — every change, every goal — affects financial outcomes. Budgeting is not an afterthought. Instead, your budget is a reflection of the goals and strategies you have for each area of your business. The figures you budget for sales and expenses will help you chart your financial performance and compare your business’s actual performance against your goals.
Financial strategies flow from your company’s vision, mission and business strategy. For example, when you develop a business strategy to grow your business within a specific market, you create certain financial expectations. You will probably forecast an increase in sales.
In addition, your strategies may include increases in marketing expenses, payroll to produce the product/service, and capital equipment purchases. Developing a budget will help you plan for the costs of implementing these strategies.
BUDGET FOR GROWTH
Like many entrepreneurs, W. Michael Scott’s financial goals for Financial Management Solutions, Inc., (FMSI) were vague when he launched his company in 1990 — he just wanted to be solvent. Yet as FMSI matured, specific financial goals began to emerge along with the need for a more formal budgeting process. FMSI hit its first financial milestone of $1 million in annual revenue in the mid-90s. Even so, a formal budgeting process didn’t surface for several more years.
That might sound surprising, especially for someone like Scott, who has a degree in business administration and established a successful fifteen-year track record in the banking industry before launching FMSI. Based in Alpharetta, Ga., FMSI provides software that helps banks and financial institutions schedule tellers more efficiently and track productivity.
Establishing a formal budget for FMSI stemmed partly from growth. “When we were smaller, the numbers were in my head but not on paper,” Scott says. “As other people came into the company, we had to become more sophisticated in documenting our financials.”
With no formal training on budget preparation, Scott developed his own financial tools, including an intensive spreadsheet with 103 line items that captures revenue and expenses in every area of the company. “Once we got the format down, budgeting became much easier,” Scott says.
Budgeting is not black and white, Scott says: “It’s an ongoing effort we revisit monthly because things change in our business.”
Accurate budgeting comes with experience, he added: “To put something on paper, you need to know what your environment is, which is difficult if you’re just starting out. It’s good to get coaching from other folks. If you form a board of advisers, try to get someone who might be a good resource at budgeting.”
Entrepreneurs and business managers use budgets to set financial goals and then to review actual performance against these goals. This regular review of the budget helps entrepreneurs get the business back on track without additional loss of time or money.
Sometimes budgets are prepared annually and not reviewed until the next budget cycle. This annual look at the budget is ineffective in helping you reach your financial goals. It’s like planning this season’s crops, planting the seeds, and then coming back at the end of the season to harvest what is there. Just as a farmer must fertilize, protect and cultivate the crops, you need to attend and adjust the budget throughout the budget cycle.
Although some people consider the budget a simple list of planned expenses, useful budgets forecast profitability (sales and expenses) as well as the cash and capital equipment needed to support sales.
After completing this program, your budget will include estimates for these accounts:
- Operating Expenses
- Fixed Asset Purchases
- Cash needed and potential sources
These estimates will be projected on the following financial statements:
- Three-year projected Income Statements
- Three-year projected Balance Sheets
- Three-year projected Cash Flow Reports