Successful business owners create an annual budget and compare the budgeted amounts to actual results each month. This process is the best way to make smart business decisions and increase profits during the year.
However, creating a budget requires a big time investment, and that’s why a business budget template can be useful. This article explains why budgeting is important and provides a step-by-step guide to creating a business budget, and a downloadable template.
Use the business budget to plan your sales, production, and costs, and to make informed decisions to increase profits.
Why budgeting is critically important
Creating a formal budget helps you validate your business assumptions, and allows you to make changes that improve business results during the year.
Assume, for example, that Sally owns Playground Sporting Goods, a manufacturer that supplies sporting goods to retailers. Sally has managed the business for years, and she has a good idea of what her costs will be for the upcoming year, and her expected level of sales.
Putting her assumptions in a formal budget forces Sally to think carefully about each budgeted amount. Playground, for example, purchases a large amount of leather material to make baseball gloves. The leather cost per square yard must be a price that her supplier is willing to charge, or her budget will not be realistic.
A formal budget isn’t perfect, but it’s a more comprehensive and accurate budget than a plan that you keep in your head. To start the year on solid financial footing, create a formal budget.
Tools for budgeting
To create a budget, you need to generate three reports:
- Balance sheet: The balance sheet lists your company’s assets, liabilities, and equity as of a specific date.
- Income statement: Your income statement reports on revenue, expenses, and net income (profit) for a period of time, usually a month or year.
- Cash roll-forward: This report lists your beginning cash balance, expected cash inflow and outflows, and your ending balance in cash for each month of the year.
While the balance sheet and the income statement are defined as financial statements, the cash roll-forward is an informal report that is only used internally. The statement of cash flows is generated as part of your financial statements, but a cash roll-forward is more useful for budgeting purposes.
Finally, you’ll see in the discussion below that the three components of your budget are linked, and you need to understand how one report can affect another.
How to budget
To produce a useful budget, start by reviewing your balance sheet and income statement for the prior year. Talk with your staff, suppliers, salespeople, and customers to make projections about sales and costs for the year.
Use the information you’ve gathered to create a budgeted income statement and balance sheet. Finally, produce a cash roll-forward for each month of the year.
Here is the budgeting template for Playground Sporting Goods, and an explanation of Sally’s budgeting process:
Step 1: Prior year information
The first step is to input the year-end balance sheet and income statement into your Excel template. Equity is the difference between assets and liabilities, and you can think of equity as the true value of your business. The $10,000 net income in the income statement increases equity in the year-end balance sheet.
Step 2: Assumptions about sales and costs
Next, Sally makes some assumptions for the upcoming year. In this example, you’ll note that Sally’s budget accounts for changes in sales, cost of sales, payroll costs, and other expenses.
Some accounting transactions, however, are unusual and cannot be included in a budget. For example, Playground had a $5,000 loss on the sale of equipment in the prior year.
Sally’s primary business is manufacturing and selling sporting goods, and the sale of equipment is not part of her annual budget. Accountants refer to these transactions as non-operating income and losses, because they are not generated from day-to-day business operations.
Step 3: Create a budget income statement
Sally produces a budget income statement using the assumptions she made in step 2. Note that the Playground budget has a line item for Gain or loss on sale, Other revenue. While the company may have an actual transaction in the category, this line has a zero budget.
Step 4: Create a budgeted balance sheet, using assumptions
The budgeted balance sheet includes assumptions that address each of the line items in the report. The budget provides a percentage increase or decrease from the prior year, and two categories have no change at all.
Step 5: Budgeted cash roll-forward for January
The cash roll-forwards should be created last, because owners need a cash projection for each month of the year. Step 5 presents the cash roll-forward for January, and you’ll see that the beginning January cash balance ($10,000) is the year-end cash balance in the prior year balance sheet (see Step 1).
The majority of cash collections are from sales, and the bulk of cash payments are for inventory. When inventory is sold, the dollar amount is transferred to cost of sales, which is the largest expense in the budget. So, it makes sense that the biggest cash outflow is for inventory.
Sally assumes that cash received for sales and the cash paid for inventory is evenly distributed over 12 months. In reality, the payments will be uneven, but the cash inflows and outflows can be difficult to predict by month.
The budget also includes miscellaneous receivables that are collected in cash, and other cash payments, such as payroll costs.
Steps 6 & 7: Budgeted cash roll-forward for February, other months
The beginning cash balance for February ($10,500) is the ending cash balance for January, and this connection applies to each month of the year. The February cash budget uses some of the same assumptions for sales and inventory purchases, and the ending cash balance for February is also the March beginning cash balance.
Sally continues this same cash roll-forward process until she has a cash budget for each month of the year.
What to do with your budget
Once you’ve invested the time and effort to create a budget, make sure that you use it to make improvements in your business.
Each month, compare your actual results to your budget, and investigate any differences, which are referred to as variances.
Assume, for example, that Sally’s January cost of sales total is $10,000 higher than budgeted. She analyzes the costs and determines that she paid a higher cost for leather material than she planned. Sally contacts her vendor and negotiates a lower price for the raw material moving forward.
Monthly variance analysis is a tool to lower costs, and to find inefficiencies in your business.
Outperform your competition
Creating a formal budget requires time and effort, but the payoff can be huge.
Investigate variances to make changes and increase profits. You may be able to find ways to lower your costs, or to speed up cash collections.
If your competitors don’t use this same process to create a budget, they may not identify areas of improvement. You’ll have the advantage over your competitors if you take the budgeting process seriously. Use a budget to outperform the competition and grab more market share.
Want more tips for managing your business finances? Check out our handy accounting 101 guide.
This article originally appeared on the QuickBooks Resource Center and was syndicated by MediaFeed.org.
Featured Image Credit: nortonrsx / iStock.
