How To Prepare An Effective Budget

Preparing an effective budget requires a solid understanding of your business plan and the goals you have set for the short and long term. When you focus on setting budget targets, you focus on the important aspects of your finances, including cash flow management, cost reduction, capital gains, improving profits and more. Budgeting is at the root of success. It allows you to remain on top of your finances and make informed decisions that greatly reduce risks and enhance your profit-building power. Here are a few tips on how to prepare an adequate budget for your business.

Set Targets

Setting targets allows you to measure your performance. Without targets, it becomes more difficult to analyse performance and see if you are reaching your goals. You can determine if you have been reducing costs or spending more than expected to see if you are under or overperforming. These types of targets allow you to make improvements and adjust your approach to become more efficient and cost-effective. 

Working with a partner to help you set realistic targets and help you meet them can make it easier to remain motivated and understand what you can realistically expect to achieve. The key is to understand your targets are not always achievable. Rather, they are a means to help steer your business toward your desired outcome. Placing too much time and focus on achieving an unrealistic target can lead to unintended consequences. Examples include:-

• Your budget too thin; and
• Increase the risk of becoming less effective in cash flow management.

Budgeting is Planning

The best way to look at budgeting is as a crucial planning tool. You can choose the type of budget that meets your needs:-

• Budgeting on an accrual basis, which makes it easier to estimate net income; or
• Budgeting for cash flow, which helps you to make spending decisions for both operating and investing purposes.

Ideally, you should include both in your budget plan. The reason being it reminds you to monitor the two most important financial key performance indicators. You want to have access to the numbers that will help you to measure targets and keep track of how well you are meeting your goals.

With a budget plan, you can estimate your revenue and expenses and assess the different areas of your operation. This allows you to understand how money flows in and out of your business so you can identify opportunities based on expected increases in capital. Your budget plan will enable you to forecast expected earnings and plan where you should spend your cash.

The Bottom-Up Approach

If your business has multiple departments, you need to take the bottom-up approach to budgeting. Bottom-up budgeting starts at the department level and then moves upwards to the overall company budget. This is the best way to see where money is needed most, who is spending or saving more and where money and people resources need to be allocated. It also provides a closer look at the projects each department is planning for the year ahead and what resources they will need to undertake their projects. You can then look at the estimates of each department, add them up and get your overall budget.

This also helps make department heads more accountable for their own budgets and helps the business prioritise particular projects for the year(s) ahead. 

Each department works together to come up with an overall budget that is better suited to meet the needs and goals of the entire business. As a result, the business collectively remains focused on overall objectives without losing sight of how their own department contributes to the organisation’s success.

How to Organize a Bottom-Up Budget

The bottom-up budget might sound complicated, but it is actually quite simple. In summary:-

• Breakdown your departments/components:- Identify the departments in your business and the projects that fall under each department. Estimate the costs for each project, including employee salary and wages, so you have accurate costs for the projects you need to tackle next; 
• Add project costs to the department budget:- Have each department make estimates for their projects and departmental operation costs and add them up to set their own budget;
• Total all department budgets:- Have each department submit their budgets so you can sum them up and total your overall budget for the company; and
• Approve the budget:- Once you have the total budget, you can review it to determine if it is manageable.

 Ask yourself some important questions to help prioritise, approve, or deny department budget requests:

• Is each project aligned with your company goals?;
• What would happen if you did not approve each project? In other words, would it negatively or positively impact the company?;
• Which projects are urgent and which projects can be pushed to the next financial period?;
• Are there opportunities to slash budgets such as reducing overtime to complete the projects, looking for more effective suppliers and negotiating a better price with vendors? and
• Are there any items or steps overlooked in the budgets provided?

Once you determine what projects are viable and worth pursuing, you can share the approved numbers with your accounting team. Where particular project budget estimates require change, they are sent back to the department heads with feedback so they can make sure their budgets are revised and aligned with the organisation’s overall objectives.

Benefits of Budgeting

Budgeting allows you to:-

• Spend wisely:- With a reliable way to review your numbers, you gain the confidence to spend wisely to avoid poor planning;
• Understand your pricing:- Budgeting helps you track spending, so you understand the costs to manufacture your goods or deliver your services. You can then look at your pricing to see if there is leeway to adjust and improve your price per unit or per hour. If you find your pricing is too high, then you need to look for ways to reduce your costs; and 
• Access to capital:- Careful budgeting with an accounting partner makes it easier to spot opportunities to access more capital. This is important for businesses focused on producing a product as it allows you to expand your offering with capital available for research and development. A budget helps you more easily identify when it makes sense to seek credit or how to reinvest profits back into your business.

Budgeting can accelerate the growth of your business by helping you to avoid roadblocks and potential disasters. However, just because you set a budget does not mean everything will work out exactly as you expect. It is worth taking the time to review and adjust your budget on a regular basis. This is known as forecasting. That is, taking your original budget and revising it for the remainder of the year based on what you think lies ahead. Think of your initial budget as a rough draft: necessary but not yet perfect. 

Bonitas Partners Pty Ltd understands that accounting is not your core business. We focus on your accounting issues, such as smart budgeting, so you can focus on operations and strategy. Our budgeting helps you find opportunities to reduce your overhead cost and access your numbers when you need them.