8 Budgeting Best Practices in 2022
A budget is a detailed report describing your future revenue and expenses. A budget is drafted at the start of the year or the beginning of a project. The budgets can be used for both professional and personal purposes.
They help achieve long-term growths like a 25% revenue increase, a 30% cost reduction, or buying a new car. Here our primary focus is on how effective budgets are for businesses and entrepreneurs and the best practices we should consider before drafting a budget.
It is not just a formal practice but the most initial and crucial practice that a business is required to do. A budget sets the foundation of financial planning for a firm. Of course, it might be hard for a company to achieve accurate objectives as stated by the budget, considering different uncertain scenarios. Still, they should always keep the final result as close as possible to the budget.
How does the budget benefit a Business?
The year of COVID-19, 2020, was one of the most surprising years for the whole world. The majority of the business suffered huge losses, and many went bankrupt. Although there were many downsides, few companies survived this difficult phase in a good way. The primary way they managed to do so was by strictly sticking to their budget for years.
Those that neutralized the effects of the economic downturn got a competitive edge. They got room for expandability as they got the lion's share of the market due to the absence of competitors.
The budget not only helps businesses in surviving complex and uncertain scenarios, but it also helps them in many other ways. Monetary management improves drastically with Budgeting. The budget helps businesses in achieving long-term objectives.
The one great advantage a business avails of from the budget is that it helps in overall decision-making. For example, a business might be planning to increase revenue and recruit more staff to boost production; this is how a budget helps a company decide. On the other hand, there might be a scenario where a business plans to decrease its expenses. For example, they may relocate to a location with cheaper rents to reduce their costs, or they may plan to adopt cost-effective production methods.
A business should always measure the performance of its staff. A budget helps in this process, too. For example, a company might have drafted an annual production budget. After the end of the year, it would analyze the productivity of each of its employees.
After analyzing, they can make decisions regarding hiring, firing, or offering promotions to existing employees. A business might also know its key performers and failures in any operation.
8 Budgeting Practices
Now that we know the advantages of drafting a budget, let's look at the best practices one should consider while making a budget. Preparing a budget is a thorough and planned process. For making a clear budget, many things need to be considered; let's look at the best budgeting practices.
1) Realistic Objectives
Any organization would want to achieve outstanding results, and there is nothing. Still, we should always keep in touch with reality. While drafting a budget, a firm should always focus on setting realistic and achievable goals. Let's say an organization plans to reduce its operational cost by 50%. Anybody would figure out that this is near impossible.
For the sake of argument, we say they accomplish this; anyone would figure out that they would have made self-destructive changes like the mass firing of employees or reducing production to half or more. So, while the budgeting process, a business needs to set goals that are possible to achieve.
A business setting goals like 7% cost reduction or 12% profit maximization is achievable. Setting objectives that can be met would generate healthy growth within the organization. At the same time, keeping the number as high as possible would eventually burden the workforce and lead to dissatisfaction and increases in resignation.
We are not saying that keep your Annual Budget as low as possible, like 2% profit maximization; this is a very low target, and inflation would get the better of your organization.
Setting realistic goals can be possible if you consider the economic situation and market conditions. The best way to do so is to be updated with the inflation, the change in fuel prices, changes in minimum wage law, and others.
2) Differentiations between Expenses
While making a budget, one thing that needs to be considered is that you have to divide your expenses. Essentially there are two types of different costs, the first fixed cost, and the other a variable cost. Fixed cost is a type of cost that doesn't often change. This includes your premises' rent, motor vehicle, or machinery installments.
Fixed cost is easy to forecast. The other cost, which is a variable cost, depends on the production level. If the production increases, the variable cost will rise and vice versa. Variable cost divided by total units produced gives us per unit cost. Variable cost is hard to forecast.
While preparing a budget, cost differentiation helps you in many ways. First, you get to know whether your expenses will increase or decrease and how this will affect profit. Secondly, you can easily prepare purchase orders from your suppliers.
Finally, you can make the pricing decisions considering the expenses and desired profit level you want to achieve. This is all regarding variable costs.
Fixed costs can also be changed with the help of a budget. For example, if a business wants to reduce its fixed price, then it might plan to relocate to a location that has cheap rents. Often governments offer grants when to populate a specific area. If a business does so, it can generate extra income, which would benefit them.
3) Unforeseen Scenarios
One of the most critical things every Financial Manager do is to set aside some of the money for unforeseen situations. We live in a very uncertain world; it is evident now in recent times after the pandemic. Uncertain conditions could erupt out of nowhere.
Setting aside some amount for such scenarios will help a business deal with these surprising and unfortunate incidents and neutralize their effect. These could include a fire at the production plant, a workforce strike, and other incidents. This would also be a part of the contingency plan. These incidents can be very destructive and tend to cause much harm. At times due to these incidents, the whole production could be brought to a halt.
Once a business effectively deals with these incidents, it would take much to recover. Therefore, the likeliness of this kind of situation is usually very low. Still, it is a definite practice that most business does. A company benefits not only in the way mentioned above but there are other business benefits.
Firstly, many lives are saved; if employees are affected due to fire, then money planned for miscellaneous expenses could be spent on their recovery. A business could also avoid negative press if they manage to decrease the effects of harmful incidents.
4) Budget Type & Various Modeling
There are mainly two types of budgets. The first is a Top-Down Budget, and the second one is a Bottom-Up budget. A Top-Down budget is drafted before the preparation of the Annual budget. It is made by senior financial management.
On the other hand, a Bottom-Up budget is prepared at the departmental level. It is created in light of the Top-Down budget with several revisions and then sent to senior management. Revisions in Top-Down budgets are standard and often made after considering different scenarios. This practice helps a business in the budget process.
There is various sort of other things that goes into preparing of budget. Financial modeling is one of the most crucial parts of the budget. These are some predictions and forecasts of various things that help a business in strategic planning.
- Workforce Modelling
This is the process in which a business analyzes and plans to make changes in its workforce. For example, a company might be planning to increase its production capacity, and henceforth it may forecast in the budget to increase its workforce.
Also, they would have to ensure that their employees are trained before work. Their payroll and other factors are also considered while creating a workforce modeling.
- Profit/Loss Modelling
A business will either have a lucrative year and make a profit at the end of it, or they will have a less good year or have to bear a loss. Profit/Loss modeling helps a business to know where they are heading. If a company forecasted that they are going to enjoy a profit at the end of the year, then they would try their level best to meet such targets. If a business predicts a loss at the end of the year, then it may plan to make decisions and revisions so that it can avoid a loss.
- Cash-Flow Modelling
Among the essential things for a business to be operational is cash flow. Businesses could be earning profits and still could be shut down if they don't have a favorable cash flow. Cash flow is the net inflow (cash coming in) – net outflow (money going out).
In cash-flow modeling, a business forecasts the amount of cash-related activities that are taking place. Cash-flow activities include loans, net income, rent received (if any) against interest payments, cash purchases, rents, electricity bills, and others.
Cash-flow modeling is essential because a business can negotiate loans on favorable terms with an excellent cash-flow prediction. The other advantage of having a subtle cash-flow projection is that they can make their purchases on credit with suppliers and provide cash-flow modeling as evidence. If modeling indicates a poor cash-flow condition, they can make necessary decisions to avoid this situation.
5) Key Performance Indicators/ Drivers
If a business needs to reap great rewards and enjoy long-term growth, it should focus on its success driver or key performers. The drivers can be the most optimal resource of a business that gives a business advantage over its compatriots it can also be a star product. Using the past data, a rolling forecast can be created that highlights drivers.
Then, while preparing the budget, a business could direct its resources to the drivers and improvise them to benefit the company. Drivers are an essential part, and they should be taken into consideration while making a budget. These make revenue-related estimates more accurate.
6) Outperforming Numbers
As we know from the earlier part, the budget would be achievable, and a firm should plan to meet those targets. The one thing that could be better than this is if a business maximizes its efforts to outperform these objectives. The one that is going to benefit from this the most is the firm and the management that is responsible for doing so. When an old board acknowledges that the budget is outperformed, they will praise the management, and the likeliness of promotion is also possible.
7) Rapid Revisions
No budget can be 100% accurate. This is because we are making estimations and predictions. There is much room for things going the other way around. A Financial Manager should always do constant revisions in the budget as future scenarios become more apparent. This would ensure that the budget cycle is up to date and realistic.
From a strategic perspective, budgets are significant. These ensure a company's smooth performance and foretell the likely situation of the future, providing enough room for business in how they should deal with these situations.
8) Make Use of The Best Tools
We have gone through all the essential steps to frame a transparent budget. The last step should be using the best tools available to make a budget. Financial software is critical to this process. These are accurate and decrease the chances of manual and calculation errors. They also have advanced features that make a hectic task like making a budget easy.
If you are looking for the perfect budgeting software, ZarMoney is the best. It is a prime financial software that will help you in Budgeting and Order Management, Invoicing, Online Payments, Managing Bills, and many others. Like several other businesses, we place our bet on ZarMoney, and so do you.