Developing an annual budget is one of the most critical aspects of business planning, but it often gets overlooked. Yet, budget planning is an essential task that many small to mid-size businesses tend to forget. So, why is it so important? Primarily because it prepares your company to answer critical financial questions and determine what the next 12 months will look like.
You’ll want to address questions 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?
Every business should have the answers to these questions to be able to plan the annual operating budget accordingly.
If you are overwhelmed by 2022 budgeting planning, don’t have a CFO, or don’t know where to begin below are some tips to help you get started:
1.REVIEW WITH All Departments
Your annual budgeting process should be completed behind closed doors by only one member of the team. Instead, all departments within the company should be a part of the conversation, providing feedback, insights, and expectations for the new fiscal year.
But, who should contribute to the conversation?
It's important to incorporate feedback from each department as your results are much more likely to be accurate. Many times companies complete their annual budget process by estimating an overall percentage increase over the prior year's invoice this can be avoided by discussing actuals with projections with the entire company.
2.Estimate Your Revenue
Expected sales significantly influence 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 your recent monthly growth rate and decide if it can be continued.
Review competitor financial information, if available.
Communicate with your current customers to better understand their expected needs of your product or service.
Discuss your expected sales with your sales team and set expectations to help determine compensation for this team.
Once the expected revenue figures are estimated, your focus can shift towards expenses. Here are some things to consider:
Some expenses relate directly to revenue, whether its inventory of employee services. Usually, the business's gross margin does not fluctuate substantially unless new products are developed, pricing changes or efficiencies in the manufacturing process are identified.
Fixed expenses such as rent, insurance, leases, and other services purchased are easier to estimate. However, they should be reviewed, especially insurance rates, as different coverages could be more advantageous.
Employee compensation should always be established with revenues and related growth in the upcoming year. Many companies believe that all employees require an annual raise in salary, but if the results show a contraction in business, this may not be reasonable. Consider other aspects of compensation that relate to the growth of the company.
Estimating employee headcount is another critical aspect of the budgeting process. Again, it's essential to identify when you will hire, how long the hiring process will take, and what experience level would optimize the operations.
4.Identify Capital Expenditures
Often not considered in the budgeting process are large or expensive purchases that are vital to the business's continued success. These may include new computers, systems, equipment, vehicles, furniture, etc. Remember, new employees will likely require a certain amount of capital expenditure.
Equipment investments that are directly related to your product or service should always be considered. For example, will you need to purchase new materials in the upcoming year? Is there old equipment that you need to update? Avoiding these investments can impact the delivery of your product, which can affect your revenue, so it is better to bite the bullet and take care of these issues now.
5.Calculate Cash Flow
While putting together a projected income statement feels fantastic, its just as important to calculate your expected cash flow. Your company may pay bills faster than others. You may need to purchase significant inventory in advance of sales. In these cases, a cash flow statement should be created using the income statement as well as AR/AP reports.
Businesses should begin the annual budgeting process by October to allow sufficient time for revisions and approval before the year ends. However, the annual budget should be monitored and updated on an ongoing basis.
Very few business owners you meet love budgeting, finances, and spreadsheets; that's not the reason they started a business. But budgeting is a part of life when you own a business. So preparing your annual budget and efficiently implementing it will make your job as a business owner a little bit easier.