Budgeting for the Small Business

A budget is a projection of future revenues and expenses for the organization preparing it. It is comprised of a balance sheet, income statement and cash for the coming year. During the year individual months can be compared to results. At the end of the year full years can be compared.

Why Create a Budget?

A budget allows you to monitor your company's operations. Your yardstick is whole dollars. Closely monitoring your operations: revenues, costs, profits and cash flow allows you to adjust as needed to stay on track and reach your goals.

How to Use a Budget

A budget is a financial yardstick to measure the organizations effectiveness in reaching the goals set by management. A budget also lets creditors know that management plans ahead in anticipation of foreseeable needs.

A Budget Will Show:

Projected revenues and the expenses needed to reach the profit goals. If your revenue projections turn out to be inadequate for the total expenses, adjust your plan by acting to raise sales, or adjust your plan by acting to cut costs. Every organization should have a budget before making any long-term decisions such as: leasing property or equipment, or purchasing equipment. The place to make adjustments is on paper where they are less costly.

The three main parts of a budget are total revenues, total cost and profits.

Total Revenue

Sales are the reason for budgeting. It is important to estimate sales based on past history and anticipating any future events that could have an impact -- including inflation. Sales are the base from which costs and profit can be estimated.

Total Costs

Total cost includes fixed, variable, and semi-variable. It is complicated because fixed costs are not dependent on a level of operations, but can change due to inflation. Variable costs change directly with the level of sales activity. Semi-variable costs have a fixed and a variable component. Inflation and Other Adjustments (price increases). A budget will be as good as the numbers used to make it. Therefore, it is important that your estimates and calculations be as accurate as possible.

Profit

Profit after tax should be large enough to make a reasonable return on your investment of dollars and time. Your targeted profit should allow for this. You can research your industry to determine if your investment is justified.

The Budgeting Process

When creating a budget, you must consider: What is your profit goal, how much will it cost to achieve, and what level of sales will support profit and costs. It is safer to overestimate costs and underestimate revenues associated with the products or services you offer.

Constructing a Budget

You can start with a forecast of sales or a forecast of profits. For practical purposes a forecast of revenues would be preferable. Then forecast the expenses necessary to make the profit target. A product oriented company would have to also forecast gross profit based on anticipated purchases, returns, freight in, etc. Adjustments would be made based on the resulting net profit after taxes and interest. The adjustments could be annual or monthly. Actual would be compared to budget monthly.

The Master Budget

A master budget is only necessary if you are tracking more than one process, activity or department. In that case you would prepare separate budgets that are interconnected by a master budget. This is typical of cost centers or profit centers.

Summary

A budget focuses the activities of an organization so that everyone is working toward common goals. Employees feel more a part of the organization and it helps them realize their importance to the organization in achieving the goals.