Growing businesses are dependent on financial success. While it may be tempting to get carried away during periods of lucrative sales, it is always important to carefully budget for future events and problems regardless of current financial situations. Therefore, employing various forms of budgeting methods to track expenses when looking at long-term performance is crucial.
Budgeting for sales prepares businesses for potential spikes and dips in revenue so they can remain flexible in their operations. This also helps when planning for future labor costs, as well as inventory expenses by determining exactly how much should be spent on each aspect of the business.
Types of Business Budgets
Depending on the management style, size, and industry of the business, methods of budgeting and preparation will naturally differ. However, there are general aspects of operations that will need separate budget plans no matter the circumstances, for example-
Operating budget This covers ongoing revenue and expenses over given periods of time.
Master budget This provides the big picture of a company's expenses. Master budgets collect information from smaller budgets and financial plans from every aspect of the company.
Finance budget This looks at additional assets and stocks such as stockholder equity and liabilities to help build a bigger picture of the company's overall health. This form of budgeting is critical when seeking funding.
Strategic budgets These budgets tend to be more conceptual and work as road maps for how a business should grow in terms of sales. The strategic plan budget incorporates financial information to create a vision for the future of the company.
Capital budgets A capital budget encompasses a business' plan for asset purchases, such as equipment or buildings for new locations. This should also include an analysis of whether the purchase is worth the potential return on investment.
Static budgets These are base financial plans for companies that experience steady and predictable sales and expenses. A static budget will not change throughout the year and businesses often use this information for evaluating actual sales performance against the static figures.
Budgeting Methods to Consider
Creating a budgeting plan can be especially helpful for businesses trying to limit operating costs and optimize business processes. With a clear data-driven plan, companies can spend only what is necessary to keep things running efficiently.
Here are the four main methods to consider-
1. Activity-based budget
This type of budgeting method involves the inputs and outputs of a company. Put simply, it looks closely at the desired outputs of a business and the inputs needed to achieve these goals.
These plans will allow businesses to carefully plan for financial targets, while taking into account growth and progression in the wider market. A simple example would be to consider a large financial goal (revenue) as an output. From here, consider what the business will need to achieve these figures while weighing the related costs needed to meet these goals such as marketing, labor and inventory costs.
2. Incremental budget
An incremental budgeting approach is a popular way to plan ahead as it is one of the simplest ways to financially prepare a company for years to come without the need for extensive data probing.
This method involves setting up a new yearly plan based on a previous annual report by taking last year's actual figures and either subtracting or adding a percentage on top to create the upcoming year's budget.
Put simply, it is predicting the future budget of a company based on the previous years' budget and historical data. This method is ideal for businesses that are unlikely to hit unexpected changes in demand. However, for businesses in industries subject to seasonality, it may not be the most effective or accurate approach.
3. Value proposition budget
Value proposition budgeting technique puts everything that goes into the financial planning under close scrutiny. Consider it a budgeting microscope of sorts. Value propositioning will consider why items exist in a budget, how much value if any they offer, and whether or not it is financially viable to continue paying for it.
Ultimately, this budgeting system allows companies to shave unnecessary expenditures from its plans and identify the main cost drivers. It is one clear way to ensure businesses are not funneling money into unnecessary channels by putting the emphasis on the value different aspects of operations offer to employees, stakeholders and consumers.
4. Zero based budget
This type of budgeting is one of the most commonly used methods, especially in times of financial struggle, and works on the basis of absolute zero.' This assumes that every department's budget is zero and therefore everything must be reconstructed from scratch. Any and all expenses will be put through intense scrutiny so each cost and purchase will need to have clear and undeniable value to be included.
Zero-based budgeting is very tight and eliminates all expenditures that are considered to be non-essential in bringing in a profit. This form of extreme bottom-up budgeting can be helpful in times of urgent need due to financial restructuring, a market downturn, or economic trouble when businesses must reduce their budgets dramatically.
Choosing the best budgeting method for a company's needs and goals is a great first step to cutting down costs and optimizing business operations. However, a budget cannot increase efficiency if it is not based on data.
Businesses can utilize forecasting methods to create projections for future cash flows, sales, demand levels, as well as operational costs. This process could be further automated using software, allowing business owners to produce the most up to date financial reports and forecasts at the click of a button. It is through utilizing this information that businesses can create more effective and realistic budgets to ensure they are on a path to financial success.