The budgeting process is a systematic and organized method that can be used for planning for profit and loss while also providing control over the financial aspect of a company. The budget process is an essential part of running a business. It should be made up of all the expected expenses and income for a set period of time, such as one month or year. The best way to create an accurate budget is by using previous figures from past months as a guide, then layering on future anticipated revenue and expenses.
Without a solid financial plan, your business could fail due to incorrect spending habits. Coming up with a realistic budgeting process is essential to making sure that your business can survive and continue adding revenue with each passing month.
Here are 6 steps on how to achieve the most realistic budgeting process for your business.
1. Go over your company’s revenue.
Examination of business revenue starts with looking at the amount of money taken in by a company during a certain period, usually one year. Revenue needs to be broken down into what the sources are (how much profit is coming from products sold, services provided, interest on loans or investments made, etc). Revenue can also be broken down by geographic location, to determine the different sources of revenue for each region in which a company operates.
The next step is to look at expenses and assets paid out by the business during that time period (usually one year). Expenses are usually divided into two categories: fixed expenses and variable expenses. Assets are also divided into two categories: fixed assets (i.e., land or building a company owns) and working capital (i.e., money kept on hand to cover bills as they come up). After all expenses have been tallied, an analysis can be done of how much profit was made by the business.
2. Examine all your fixed costs.
Fixed costs are those expenses that don’t change as the number of business increases or decreases. Examples of fixed costs include rent, insurance, advertising costs, and utility costs. Fixed costs can also be categorized into three different types:
- Total Fixed Costs- Total Fixed Costs are the total expenses associated with a business. By adding together every single fixed cost, you get the total fixed costs for a company.
- Fixed Costs per Unit- Fixed Costs per Unit are the fixed costs divided by the quantity of items produced.
- Average Fixed Costs-Average Fixed Costs are the total fixed costs divided by the number of units produced.
3. Calculate your variable expenses.
Variable expenses are costs that change in proportion to changes in sales. Variable expenses will increase as sales go up and decrease as sales go down. Examples of variable expenses include things like the cost of raw materials, commissions, or royalties. The best way to determine what your variable expenses are is by keeping track of how much you spend on each expense. This will be different for every business.
There are two ways to calculate variable expenses. Variable expenses can be calculated either by averaging the amount spent in proportion to sales or by dividing your change in revenue by your change in units sold. The first way is simply multiplying total sales by the average of the variable cost/total sales ratio. The second way is to take your change in revenue and divide it by your change in units sold.
Examples of expenses that could be included as part of a business’s variable expenses:
- Commissions and royalties
- Insurance and rentals
- Wages if the business is labor-intensive. This will be more variable than a business that has a lot invested in its equipment.
- Materials used in the production of the product
4. Factor in an emergency fund into your budgeting process.
The way to set up an emergency fund is to deposit a certain amount of money into a separate bank account each month. This way, in case something unexpected comes up in your business, then you have some wiggle room. This might not be necessary if your business is a large company with a lot of income, but if you are one person working out of your apartment and you don’t have a steady income yet, then this can be very useful.
If you want to make sure nothing slips through the cracks when it comes to the funds in your emergency account, then you will need to keep track of how much money is in that account at all times. This way, you can determine if you’re running low on funds and need to put aside more each month to make in case any problems crop up.
5. Create a profit and loss statement.
To create a profit and loss statement, start by making two columns in which to divide up revenue and expenses. Begin with the revenue section on the left side of the paper, listing all possible sources of income under one column. Beneath each source of income, list out expenditures that can reasonably be associated with it.
Next, list out all fixed costs under a separate column from variable costs. Variable costs are those that fluctuate month to month depending on how many units you sell or produce. Fixed costs do not change from one period of time to another and remain the same every month, so they will remain static throughout your report. The final thing you need to do is subtract the total cost of revenue from the total income brought in each month. Once that figure has been determined, divide it by the number of months for which you are keeping track. This figure should represent your monthly profit (revenue minus expenditures minus fixed costs). However, since there are 12 months in a year, this figure should be multiplied by 12 to get your yearly profit.
6. Once you’ve established the history of your expenses, it’s time to create the budget.
Creating a budget is essential for any business. First, you have to figure out how much money you have available each month and what your expenses will be. Once you know your income and expenses, record both of those figures on paper. In order to create a realistic budget that reflects the actual amount of money coming in and going out, it is important to review your expenses. Be sure to include all necessary costs in the budget, such as the cost of merchandise or supplies, salaries for employees, rent or equipment lease payments, and utility bills if applicable. The best way to create an accurate budget is by using previous figures from past months when possible.
If you are trying to figure out how much money you have available to spend each month, start with your income. If you are not yet making any revenue from the business, use an estimate of this number based on a potential sale or service. Then, using a calendar or a spreadsheet program, list all of the expenses that will be incurred for that time period. Include everything in this list and do not leave anything out. If you think that you will be spending an additional $100 on supplies each month, add that to the expenses for that time period. The next step is to determine if there is money left over after all of these expenses have been paid. If so, great! That money can be used in other parts of the budget or even in payroll. If not, you have to go back through your list and see where the money is being spent so that it can be reduced in some way.
The budgeting process is important in a business because it helps keep track of how much money is coming in and going out. In order to make sure that your budget is accurate when everything has been written down, consider consulting with a knowledgeable business like Consult Your CFO for a final go-around.