Beginner Budgeting

Beginner Budgeting

When you sit down to think about your plans for world domination, the possibilities seem endless. The only problem is - you don’t know how to turn that into numbers. Today we will explore some budgeting basics that will imbue with the confidence you need to take on the challenge.

Budget vs. Financial Model

Let’s take a moment to define our terms. A budget is a distillation of your business strategy represented in numbers. If you think about your business in terms of a bunch of bets, a budget is simply the expected cost and payoff of those bets over a period of time - usually a quarter or year. Some bets are riskier, such as R&D, while others are more certain, such renewing a contract with a longtime customer.

Ok, then what is a financial model? A financial model is a tool that takes your budget and projects it into the future to determine the outcome of your budget decisions (strategy). We will cover financial modeling basics in another post, but for now just know that the two of these things work together. For example, you could put your budget into a financial model, and decide it isn’t going to produce the results you want. Then you would tweak your budget, put it back in the model, and so on until you are comfortable with the expected outcome. In practice, these two components are often blended in the same spreadsheet, but we will think about them as separate for now.

Tools of the Trade

The number of shiny new budgeting tools is rapidly approaching the number of stars in the Universe. That is to say, it can be overwhelming to pick the right solution for you. I highly recommend getting familiar with Excel. It will pay dividends in the long run, especially when you want to build a financial model component to add to your budget.

If you are dead set on using another tool, make sure it is inexpensive and user-friendly. Most SaaS products these days have some kind of trial period you can use to assess whether it will work for you. The last thing you want is to spend money on something that frustrates you and eventually gets abandoned.

The most frequent reason my clients told me for not having a budget was they were overwhelmed with it. If that is the case, do not be shy about pulling in some experienced help if you need it. Money spent with the right financial advisor will more than pay for itself. That said, I still recommend trying it yourself first, as it isn’t as daunting as you might think.

Components of a Budget

There are a few “must have” components in an effective budget. There are different types of budgets, but since cash flow is usually the most important piece of a growing business, we will explore cash flow budgeting for today. At a high level, we are tracking the expected cash inflows and cash outflows of your business over a period of time. With that in mind, here are some pieces we should consider:

  • Beginning Cash Balance - the balance of the cash accounts of the business at the beginning of the budgeted period.
  • Expected Revenue - the breakdown of income (usually by client or business line) during the period.
  • Expected Expenses - the breakdown of expenses (usually by variable or fixed cost) during the period.
  • Accounts Receivable - any increase or decrease in the company’s accounts receivable balance during the period.
  • Accounts Payable -  any increase or decrease in the company’s accounts payable balance during the period.
  • Capital Expenditures - purchases of assets that exceed the amount you can expense, but cause a cash outflow for the company. (Ex. buying a company vehicle).
  • Stock Issuance or Redemption - selling or buying back any of the company’s stock to investors.
  • Debt Issuance or Payments - increasing or decreasing (through payment or redemption) the debt of the company in exchange for cash.
  • Ending Cash Balance - the beginning cash balance plus the sum of all the cash inflows and outflows of the other components of the budget.

The great thing about budgeting is you can make it as granular as you need it. There is always a tradeoff between simplicity and complexity, so I recommend making it only as specific as it needs to be to model the payoffs and costs of the bets you are making (i.e. your strategy). If you are optimizing for cash, your cash balance should be higher at the end of the year than the beginning. Note that is not the same thing as profitability. If you want to make sure your profitability is driving the increase (versus just selling a lot of stock of issuing debt), then subtract your revenue from expenses and adjust for any changes to accounts receivable and payable.

Budget Variance Analysis

One of the best ways to analyze your success in budgeting is to compare it to the actual results from the period you have budgeted. If your budget is for a year, then I recommend doing a monthly review of the actual performance of the business against the numbers you entered in the budget for that month. This process is called budget variance analysis. Over time, you will get good data on how close or far away you were from predicting the outcome of the bets you made for your business. This data helps you make better estimates going forward so that you begin predicting with ever tighter margins of error. It will also help you make better assumptions when it comes time to feed your budget into a financial model.

I hope you now feel the confidence necessary to undertake this project. They say proper planning prevents poor performance, and there is no better way to plan the growth of your business than to start with a budget as it forces you to identify the growth strategy for your business and turn it into an analyzable set of numbers.

For answers to questions you have about this or related topics, schedule your free consultation today.