Crafting an annual budget is one of the most important financial aspects of a business, but often gets overlooked.
Business budget planning is an essential task that is frequently neglected at small and mid-size companies. So why is it so important? Well, mostly because it is a process that prepares your company to answer critical questions about what the next 12 months will look like:
- What are you projecting sales to be next year?
- Are you expecting margins to improve next year?
- Do you plan to hire additional employees?
- Will you have any significant capital expenditures soon?
These questions (and many others) are typical of investors, financial institutions, potential strategic partners, and financial buyers. Every business, regardless of size, should have the answers to these questions to be able to plan the annual operating budget accordingly.
Having a chief financial officer, or CFO, as part of your company’s C-Suite executive team can be an asset in this process.
A CFO will have access to and be up to date on the most recent financial data pertaining to the company. These resources can help the company craft its budget, as well as short and long-term financial goals. Strategic budgeting is a skill that any good CFO will have in their arsenal. It’s just a matter of working as a team to bring all the relevant information together to plan for the future.
Read more: What CEOs Need From Their CFO
If you are overwhelmed by company budgeting planning, don’t have a CFO, or don’t know where to begin, below are some tips to help you get started:
1. Consult All Departments
The annual budgeting process should not be completed behind closed doors by one member of the accounting or finance team. Instead, all the departments within the company should be part of the conversation and provide feedback, insights, and expectations for the following fiscal year.
Who should contribute to the conversation? Be sure to loop in:
- The sales team: they can assist with realistic revenue assessments
- The manufacturing or service team: they can advise on costs of delivery and any large purchases required to update machinery
- The research and development team: they can discuss expected expenses as well as the timing on any new products anticipated
- Any other departments who can add value to the conversation
It is encouraged to incorporate feedback from each department as the results are much more likely to be accurate. Therefore, project completions are possible for the upcoming fiscal year. Too often, companies that do complete the annual budget planning process estimate an overall percentage increase over the prior year’s actual income – this is something that should be avoided.
2. Estimate Revenues
Expected sales have a significant influence on costs, including employee headcount, but it can be very challenging to make projections accurately. Here are some ways to come up with the best estimate:
- Consider the recent monthly growth rate experienced by the company and decide if it can be continued.
- Review industry guides and other expert publications that focus on your industry.
- Review financial information from a number of your competitors, if available.
- Communicate with your current customers to better understand their expected needs of your product or service.
- Discuss the expected sales with your sales department and set expectations to help determine compensation for this team.
3. Determine Expenses
Once the expected revenue figures are estimated, the focus can shift towards expenses. Here are some considerations:
- Some costs relate directly to revenue, whether they be inventory or employee services. Typically, the gross margin of a business does not fluctuate substantially unless new products are developed, inventory prices change, or inefficiencies are identified within the manufacturing process. Use this time to challenge your employees to identify cost savings related to the delivery of products or services.
- Other expenses are fixed costs such as rent, insurance, equipment leases, and certain other services purchased. These expenses may be easier to estimate; however, you should consider reviewing the policies in place, especially around insurance. Use this time to determine if better insurance rates are available or if different coverages would be more advantageous.
- Employee compensation should always be established to be in line with revenues and related growth in the coming year. Many companies believe that all employees require annual raises, but if the results show a contraction in the business, then it may not be reasonable. Consider tying aspects of compensation to the growth of the company. With today’s inflationary trends, make sure you include cost of living wage increases for your employees in your budget and projections as well.
- Along with compensation, estimating employee headcount is a critical aspect of the budgeting process. It is important to identify when you will need to hire, how long that hiring process takes, and what experience level would optimize the operations.
4. Identify Capital Expenditures
Often not considered in the budgeting process are those large or expensive purchases which are vital to the continued success of the business. These may include new computers, systems, machinery, vehicles, furniture, etc. It is essential to keep in mind that each new employee hired will likely require a certain amount of capital expenditure.
Investments in equipment or processes that are directly related to your product or service should also be considered. Will you need to purchase any new materials next year? Is there old equipment that needs to be updated? Avoiding investment in equipment can impact your output, quality, or delivery timing, which can directly impact your revenues.
5. Calculate Cash Flow
While putting together a projected income statement can feel great, it is just as important to calculate the expected cash flow of the business.
Your company may pay bills faster than customers pay theirs. You may need to purchase inventory well in advance of sales if acquisition time is significant. In cases such as these, a cash flow statement should be created using the income statement as well as AR/AP turnover rates and other metrics from the balance sheet.
6. Be Conservative
While it may seem advantageous to show investors that the company will significantly grow, it’s a possibility that results may disappoint. Even worse, business decisions may have been made using such projections (aka best guess scenarios). When in doubt, it is a good idea to be more conservative and leave some room in the projections in case of emergency, unforeseeable large expenses, or a drop in revenue and sales.
7. Start Early
Businesses should begin the annual budgeting process three to four months before the start of their fiscal year to allow sufficient time to craft a detailed estimate before the year ends. However, the annual business budget should be monitored and updated on an ongoing basis. For this reason, it’s never too late to get started.
8. Monitor, Evaluate & Reforecast
Once you complete the budgeting process, the biggest mistake you could make is to file it away only to pull it out again at the end of the following year.
A budget should be monitored monthly, or sometimes weekly for smaller companies. Budgets should be edited if circumstances change, like bringing in more fruitful accounts or losing critical customers.
If you have a CFO on your team, they can help facilitate a strategic forecasting process that extends beyond the annual budget and encompasses more of a three-year plan. This can help push your company to think about future business decisions and goals.
Furthermore, budgets should always be compared to actual results to understand why there are differences. Doing this will help monitor spending money throughout the year and help management make important decisions in relation to the business. Put these tips into action and learn how to prepare an annual budget with our in-depth guide.
We Can Help
Signature Analytics will help guide your company through the annual budgeting process. We will work with your management team to create a budget for your business and monitor that budget throughout the year.
This would include analyzing the budgeted versus actual results quarterly and helping forecast accordingly. We can also perform industry and economy reviews to assist with the forecasting process and provide benchmarking data.
If you want assistance creating (or improving) an annual budget for your business, contact us today for a free consultation.