Doing the annual budget? You might not know where to start if you’ve never created a business budget before or if your company has grown substantially more complex than it was the previous year. We’ve put together a brief primer on creating an annual budget to get you started.
The Objectives of Your Yearly Budget
Let’s take a minute to discuss the significance of developing an annual budget before moving on to the methods for doing so.
- Prevent running out of cash. The first reason is probably the most obvious: in order to prevent running out of money, you should make a budget. Your budget not only helps you determine how much money you can spend, but it also keeps track of what you spend so you can make adjustments if it deviates from your plan. Although it’s not the sole goal, this is one of the main ones for which you should budget.
- Gain insight into the future direction of your company. An annual budget is a task of preparation. You must determine where you anticipate to be over time in order to create your annual budget. This includes making plans for future expansion or modifications to the firm in addition to preventing overdrawing on the accounts.
- Determine your company goals. You must comprehend what influences your results in order to make future plans that will work. Examining your business indicators and how they impact outcomes should be a natural step in the budget-writing process. Website traffic and sales leads are two examples of revenue drivers; if they increase, your revenue may as well.
- Decide what has to be changed in order to see results. Once you’ve identified your business drivers, you may use that information to create various scenarios depending on those elements in your budget. If you increased funding for an area that supports a major driver, how would things change? If you were forced to cut back on expenditure instead, how would they change
Your budget is crucial for addressing these issues and giving you a deeper understanding of your company, in addition to helping you avoid a financial crunch.
Things to Consider Before Creating a Budget
You must project how your company will perform over the following twelve months, as your budget is for the full year. That’s why it makes sense to thoroughly consider your intentions for the following year and how they might impact your income and spending when you sit down to begin your annual budgeting process.
- Think about impending company adjustments. You probably have a fairly clear concept of what you want to accomplish during the following year, even though life can throw you a curveball from time to time. Are you going to introduce a new service or product? Employ additional people? Change offices or perhaps go entirely remote? Your budget will be impacted by all of these factors, including projected revenue from a launch, costs associated with hiring more staff, and altered rental status. Your expectations for the impact should be reflected in your annual budget plan.
- Establish targets for margin and profitability. If your business is profitable or you intend to become profitable this year, you undoubtedly have margin targets that you would like to hit. Similarly, in order to be profitable, you will also need to keep a specific margin. It is possible to work backward from those goals and determine what steps are necessary to reach them by keeping these margin needs in mind while you prepare your annual budget.
- Make arrangements for fundraising. Your available resources will be greatly impacted by your fundraising expectations, whether you choose to raise a round or obtain a business loan. If fundraising takes longer than anticipated, you’ll need to figure out how to spend the extra money and how to allocate it while creating your budget.
How to Create an Annual Budget
There are two components to think about while creating your company’s budget: cash inflows (the amount you anticipate making) and outflows (the amount you want to spend on things like product development or ongoing business expenses). Thus, the outcome could resemble this:
An example of a company budget:
Let’s examine each section’s meaning in more detail.
Income. This is the revenue of your business. Typically, this refers to sales revenue, but it also includes income from other sources like rent on real estate your business owns, royalties from licenses, etc.
If your company offers services or subscriptions, you should provide your annual recurring revenue (ARR). This is calculated by dividing the total amount of money you get from your service contracts by the duration of the contract. For instance, your annual revenue rate (ARR) for a client that pays $9,000 for a three-year membership would be $3,000. If your company provides software as a service (SaaS), this is a useful KPI to monitor even though it does not immediately affect your financial statements.
COGS, or cost of goods sold, is divided by cost of revenue. This covers the cost you incurred in producing your good or service. Costs of labor and raw materials are included in the cost of goods sold (COGS) for businesses that sell tangible goods; for businesses that sell software or services, COGS includes all expenses directly related to offering the software or services to your customers, like server hosting. (Take note that expenses related to promotion, such as sales and marketing, are not included in COGS; instead, they will be paid for separately.)
Total Income. This is the profit margin you achieve from sales before deducting any additional charges or expenses. Take your revenue and deduct your COGS to get your gross profit. The remaining sum is your gross profit.
Gross profits are an important indicator of how effectively you produce your goods, even though your real earnings would be smaller because of additional charges such as taxes and running expenses. Consequently, low gross profits indicate that you need to look into ways to reduce your cost of goods sold or raise your revenue.
Payroll-related operating costs. Any costs incurred in relation to paying your staff are included in this category. Payroll taxes, health insurance, paid time off (PTO), and any other benefits you provide to staff members are included in this in addition to salary.
Operating costs not related to payroll. One of the most important lines in your budget that indicates whether or not your regular business operations are profitable is this one. Take your gross profit and deduct your entire operational expenses (payroll + non-payroll) to arrive at this figure. If the figure is positive, your company is making money overall. You are running at a loss if the figure is negative.
As most businesses don’t turn a profit for years, an operational loss in this case won’t come as a shock. But this figure is important since it lets you know how your business is currently doing and whether it’s adhering to your goal.
Net Profit/Loss. After all, this is your overall income or loss after deducting expenses from your gross profits. This could be the same as your operating income or loss if there are no other expenses incurred in addition to your operating and capital costs. Your net income, however, will be your working income less any outstanding expenses if you do (for instance, if you owe state franchise taxes).
Keep in mind that this is not always your “cash burn” because the financial budget does not accurately reflect the inflow and outflow of cash, particularly if your accounts are done on an accrual basis. Your real cash burn, for instance, may be influenced by the date of your rent payments and customer payments. One reason annual prepayments can be so beneficial for startup cash flows is because of this.
How to Get the Figures You Need for Your Budget
It’s time to calculate the figures that you need to enter into your budget outline now that you have the data necessary to create one. These figures come from projecting your budget and your financial statement.
Statements of Finance
The financial statements of your company are where you should start if you want the information necessary to create your budget. Every statement offers unique, useful information.
- Your balance sheet provides information on the status of your company at a particular point in time. It shows the current assets and liabilities of your business, including the amount you owe on credit card bills and unpaid vendor invoices
- The income statement, also known as the profit and loss (P&L) statement, provides you with an overview of the revenue and expenses incurred by your company during a given time frame. Analysing your company’s trends might help you predict potential future developments.
- The company’s cash inflows and outflows are displayed on your cash flow statement. This is helpful for figuring out how much cash you make and looking at the way you spend it now.
Forecasting Budgets
Nobody ever forecasts a budget perfectly, and accuracy is unusual. But you can take action to arrive at a particularly informed guess. How?
- Make use of your data resources. Utilise your financial accounts as previously mentioned, and if you have access to any past data, utilise it as a source for potential trends. It’s okay if you don’t have any previous data; everyone starts somewhere, and the following year will bring more information for you to examine.
- Analyse patterns and consider what is (or is not) changing. You might see patterns when you examine the information from your financial accounts and other sources. Perhaps your spending in a certain area have been constant, or perhaps you have been rising sales at a consistent rate. The second question you should ask yourself after identifying a trend is whether there is any cause to believe it will continue. You can fairly assume your figures will stay the same or comparable if there isn’t, for instance, if you don’t intend to hire more sales representatives or if you don’t expect to adjust your spending in that area.
- Utilise your patterns to calculate the impact of alterations. If major changes are in your plans, you can extrapolate the impact using the trend data. If you have two sales representatives and your monthly sales average is 10, for instance, you may calculate that adding a third representative will boost your monthly sales to fifteen.
Not sure how to create your yearly budget? We are able to assist.
Creating an annual budget may be difficult, even for seasoned business owners. The efficiency and timeliness of your budget can be greatly impacted by professional advice. Seeking guidance from an expert in the field is imperative if you lack prior experience in finance.
Fullstack can provide your business with access to an expert virtual CFO to help you get ahead on your finances. A cost-effective method to acquire professional advice on creating an annual budget that will position your business for success is to work with Fullstack’s CFO Services.
