A budget is a spending plan that accounts for income and expenses over a set period. This period could be a month, a week, a quarter or a year. Budgets are used by households, businesses and governments alike to ensure that there is sufficient income to cover necessary spending throughout a period.
This type of financial forecasting is an especially important task for businesses as it helps them to gauge their profitability. In order to ensure that their operational expenses and debts are covered by their income, companies need to keep a close eye on their finances. Careful year-on-year planning ensures that businesses are able to invest in making their operations more efficient and building a framework for profitability.
None of this would be possible without budgeting.
Examples of a business budget
Businesses of all shapes and sizes need to budget. In its simplest form, a budget is a forecast of revenue (income) and expenses over a given period. This may be a month, a quarter or a financial year.
However, there are also several specific types of budget that help to ensure the financial health of a business in slightly different ways.
The master budget typically forms the foundation for all other company budgeting. The master budget usually encompasses the whole financial year, and includes projections for revenues, operational expenses, sales and capital investments.
An operational budget includes all the money spent and acquired in the company’s day-to-day operations. It will cover revenue from sales and the Cost Of Goods Sold (COGS).
Some organisations such as nonprofits and government departments have a static budget for the year. This means that they have a fixed income for the year and may also have fixed expenses. A static budget is not influenced by outputs like production or sales.
However, that’s not to say that only non-profits can use static budgets. Many companies use a static budget as a baseline and make adjustments at the end of the year depending on whether more or less is needed.
Cash flow budget
A cash flow budget helps to determine how much money is generated by a business in a given time period.
It tracks income from sales and other revenue streams by closely monitoring accounts receivables. It also tracks operational expenses, debt repayments and other outgoings to ensure that there is a safe operating margin.
Why is budgeting essential for businesses?
Without careful budgeting, SMEs can easily lose track of the flow of money into and out of their companies. This could result in unpaid debts, unnecessary fees and charges, or soured relationships with vendors.
Allows businesses to invest money in equipment and assets that could aid growth (capital investment)
Ensures that businesses are saving for unforeseen expenses, thereby insulating themselves from risk
Ensures that payment can be made to vendors and suppliers, helping the business to maintain a good business relationship with them
Aids cash flow and helps businesses to avoid high-interest borrowing like bridging loans or business credit cards
Enables businesses to set budgetary goals in order to manage their money more efficiently
How to build a budget
Although the economics of business are very different from those of the household, building a budget is much the same in both cases. Here are some important things to consider when building a budget:
Make sure you definitively understand your income and expenditure. These are the raw materials from which your budget is made
Establish clear goals
Prioritise capital expenditures that fuel growth
Invest in tools that will identify areas of wasteful spending
Identify potential risks and establish a plan to mitigate them
Set aside some cash in reserve for unpleasant surprises
Remember that vendors’ costs are not necessarily set in stone and may be renegotiated, especially if your account is in good standing
Revisit your budget regularly as your needs and goals change
Sticking to a budget
In both personal and business finance, it requires great discipline to stick to a budget. Business leaders can be prone to impulsive spending or spending in areas that are not proven to drive business growth or profitability.
Businesses can ensure that they stick to their budgets by:
Establishing spending thresholds for different departments
Ensuring that spending above this threshold is approved by senior management
Leveraging business intelligence to flag unnecessary or wasteful spending behaviours
Frequently asked questions about budget
What is the difference between a static and flexible budget plan?
In a static budget, income and expenditure figures are unchanged throughout the given time period. Regardless of changes that occur to the company’s finances, the budget remains the same. Flexible budgets, on the other hand, can change in line with fluctuations in sales, production volumes, or external circumstances.
What are budget variances?
A budget variance is the difference that can arise between a fixed budget and the real-terms results that a company’s finances experience. If the budget ends up being greater than accounted for it is classed as favourable. If the budget is less than expected, however, it is classed as unfavourable.
Why is it important for businesses to budget
Just as it is important for households to budget in order to keep their finances on track, businesses must budget to ensure that they remain profitable. Budgeting forces businesses into good behaviours when accounting for spending, looking for opportunities to cut unnecessary costs and seeking out chances to maximise their revenues.