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What is Business Budgeting?
Business budgeting is the process of creating a financial plan for a specific period, such as a quarter or a year, that estimates both income and expenses. This financial document is crucial for business owners, executives, and managers to ensure that their organization or team has the necessary resources to execute initiatives and reach their goals.
A basic budget typically includes projected income and expenses, and once the expenses are subtracted from projected income, the leftover amount can be used to fund various projects and initiatives. The goal of budgeting is to avoid overspending, and it allows businesses to make informed decisions about their expenditures.
Businesses can use budgets from previous periods to compare with their actual financial allocation and performance to determine how closely their predictions matched their actual spending.
For example, suppose a company allocated $10 million for its annual corporate social responsibility (CSR) project but due to unforeseen circumstances, the project ran $1 million over budget, causing the company to take funds from other projects to cover the additional expenses.
During the project's postmortem analysis, questions may arise, such as "Why did we go over budget? Was there any inefficiency or misallocation of resources?" By reviewing these issues, business owners and managers can use the insights to improve the budgeting process and more accurately allocate funds to other projects for the next year.
Budgeting is a crucial activity for businesses, and there are different types of budgeting that prioritize different factors when creating a financial plan.
Types of Budgeting
Zero-based budgeting is a method where each budget item starts at zero dollars at the beginning of each period. The company then reallocates the funds according to their priorities for that period.
Static or incremental-based budgeting is a method that uses historical data to make incremental adjustments in the upcoming period's budget.
Performance-based budgeting emphasizes the cash flow per unit of product or service.
Activity-based budgeting starts with the company's goals and works backward to determine the cost of achieving those goals.
Value proposition budgeting assumes that no line item should be included in the budget unless it directly provides value to the organization.
It's important to note that the right budgeting type varies depending on the company's situation. For example, if the organization is in financial distress, zero-based budgeting may be the best fit since it starts from scratch each period. Trying out several methods is a good way to determine which is ideal for the company, but it's crucial to ensure that the entire organization is aligned with the chosen method.
WHY IS BUDGETING IMPORTANT?
Budgeting is a crucial process that requires careful attention to detail, number-crunching, and informed decisions about fund allocation. Despite the effort involved, budgeting is important in business for several reasons.
1. Ensuring Resource Availability
At its core, budgeting ensures that an organization has sufficient resources to meet its goals. By planning financials in advance, a business can determine which teams and initiatives require more resources and where it can cut back. This can help businesses allocate resources more effectively and efficiently, and avoid overspending.
2. Setting and Reporting on Internal Goals
Budgeting can help businesses set and report on financial goals. By using budgeting to determine how much revenue is needed to reach company goals, businesses can set company-wide and team financial goals that align with them. This is especially prominent when using activity-based budgeting. Financial goals should be attainable, and businesses can use them to inform the rest of their budget allocations. Budgeting can also help businesses track progress and revisit goals for the next period.
For instance, if a company aimed to gain 10,000 new users in the past year but fell short by 4,000, budgeting can help businesses identify the reasons for falling short, whether there was a need for fund redistribution, and what resources could have propelled progress. By tracking progress, businesses can align their teams and plan for growth in the next period.
In summary, budgeting is important in business because it helps businesses allocate resources more effectively, set and report on financial goals, and track progress towards achieving them.
3. It Helps Prioritize Projects
Budgeting requires companies to prioritize projects and initiatives by considering their potential return on investment, how they align with company values, and the extent to which they impact broader financial goals. Prioritizing tasks and larger initiatives is useful for project management, especially when using the value proposition budgeting method, which requires determining and explaining the value of each line item to your organization.
4. It can Lead to Financing Opportunities
Documented budgetary information is important when seeking outside investors. Investors value a company's current, past, and predicted financial performance when deciding whether to fund a company. Providing previous period documents with budgeted and actual spending can demonstrate your ability to handle a company's finances, allocate funds, and pivot when necessary. Some investors may ask for your current budget to understand your predicted performance and priorities based on it.
5. It Provides a Pivotable Plan
A budget is a financial roadmap for the upcoming period. It shows how much should be earned and spent on specific items if all goes according to plan. However, the business world is unpredictable, and circumstances beyond your control can impact revenue or cause priorities to change at a moment's notice. In such cases, a budget can serve as a "pivotable plan." Maintaining an agile mindset enables companies to pivot their plans when necessary and lead the organization through turbulent times. The shift toward zero-based budgeting has been noted by McKinsey to determine the minimum resources necessary to survive as a business if circumstances require it.
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