Budgeting

Why It is Important for a Company to have Budget?

Running a business often requires owners to carefully plan and review their finances. Most companies use some form of accounting for identifying, measuring, analyzing and reporting their financial information. Accounting tools may include budgeting, financial statements, forecasts and other tools for managing financial information. Business budgets for maybe one of the most important accounting tools of company may use in their business.

Budgets usually represent a detailed analysis of how a company expects to spend money in future time periods. Many companies create budgets on an annual basis so they can carefully outline the expected needs of each department in the business. Using an annual budget process also limits the amount of time companies spend creating and managing capital resources. Although larger companies may have employed accountants or other professionals to create the business budget, small business owners are usually responsible to complete this function themselves.

A major benefit to using a business budget is the ability to limit how much money is spent on certain operations. Budgets usually count expense accounts to ensure that capital is not wasted on unessential items or the company does not overpay for economic resources used in the business. Limiting the amount of capital spent by the business may require owners and managers to find new vendors or suppliers for acquiring business inputs, saving money and meeting budget limits.

Budgets often allow companies to have a financial roadmap for business operations. Many companies review previous year’s budgets to determine how well they followed the guidelines and why budget variances occurred. Not all budget variances may indicate a negative business situation. If budget variances occurred due to unexpected growth in sales revenue, companies may need to increase the budget amounts for future sales increases.

Companies often use budgets to plan for future business growth and expansion. Capital saved on regular business expenditures may be placed into a special reserve account designated for selecting new business opportunities. Budgeting for future growth opportunities ensures that companies have capital on hand when needing to make a quick decisions for expanding business operations. This capital may also be used during slow economic times as a safety net for paying regular business expenses.

Using a business or accounting software package may help companies automate their budget process and keep track of expenses electronically. These software packages may also gather or collect information from the company’s accounting department to create a simpler process for creating and managing budgets. These software packages are usually an invaluable tool for managing financial information and reviewing information in a real-time format.
In any business, it usually is advantageous to prepare various statements related to the finances and performance of the company. One of these is the income projection statement. These statements look ahead and make some estimates about the company’s financial status that is the profits the company will have at a given point in the future.

An income projection statement is a formal document prepared by finance or accounting officers within a company. Income projection statements look at the monies the business will gain over a specific period, normally one year, minus anticipated expenses for that period. Because getting a final figure for income means looking at monies both gained and lost, income projection statements sometimes are called profit and loss statements.

The primary purpose of creating an income projection statement is to figure out how much money the company will generate in the future. This is important for planning, including the company budget. By looking at the income projection statement and comparing it to records showing what actually happened, company managers can identify possible problems and devise ways to address them. A secondary purpose of an income projection statement is to support loan proposals. Investors can look at the company’s projections and the related documentation and analyze whether the projections are accurate. If the projections are well-founded, the lender may believe the company has a good ability to repay what it borrows.

The content of an income projection statement is very similar to that of a budget. For example, the income statement notes estimated sales, loan payments, earnings on investments, salaries and wages, payroll expenses, rent and utilities. It is largely this similarity that makes income projection statements so valuable for budget work.

The most concise way to present an income projection is a chart or graph. A statement might also include short explanations of items on the chart or graph. The preparer may provide the income projection statement alone or as part of a larger, formal written report.

Creating a budget that does nothing more than set spending limits can damage a small business by preventing it from reacting to market conditions. A flexible budget helps you to adjust spending, increase marketing to expand sales, react to an unexpected drop in revenues and otherwise operate your company using real-time data to keep it on track.

Forecasting

A business budget not only helps you project annual expenses but lets you see costs as they will occur. For example, averaging your insurance premiums per month helps you set average monthly revenue goals. Budgeting the exact amount of money to pay premiums in the months they come due helps you manage your cash flow to ensure you have money on hand to pay your bills each month. Budgets also let you forecast your annual bottom line using more than one revenue scenario.

Price Setting

Market conditions such as your competitors’ prices aren’t the only parameters you need to set your fees, rates and prices. You must know your manufacturing and overhead costs before you set your prices. A budget lets you project your utility, health care, marketing, rent, wages, debt service and other costs so you can learn the true cost per unit of making your products or delivering your service. Once you know this, you can set your prices to make the profit you want. If this price is too high for you to be competitive in your marketplace, you can use your budget to identify areas where you can reduce your costs.

Capital and Credit Procurement

Few venture capitalists, banks, suppliers or other lenders will give you money or credit unless you have financial data to demonstrate you are a going concern. Unless you have assets you can use as collateral, you’ll need to show financial statements that prove you are stable. If you are a new business, or are expanding, a budget will show potential partners how their participation will affect your sales and profits.

Flexibility

A budget lets you track your business’ performance throughout the year, allowing you to make necessary changes to rein in costs or increase spending to take advantage of growth opportunities. If your marketing is effective, a budget will let you know if you have funds available to increase your advertising to grow your sales. If your sales are slow, a budget identifies areas where you can cut discretionary costs to make you more competitive or tide you through slow periods.