Creating and using a budget is a key component in driving your organization’s financial future. Yet there can be many questions. For some, the biggest one may be, “How do we start?” Or if you are already using a budget, “How can we make our budget better?”
This top 10 list offers guidance. Even if all 10 of these tips won’t work for your organization, just by adopting a few suggestions you can make your organization’s budget a more effective tool.
1: Understand What a Budget Really Is
A budget is not meant to manage every penny spent. It is simply a guide to assist you in making better spending decisions. A budget can also be an eye-opening tool that identifies areas for improvement.
When creating a budget, it’s important to maintain the right mindset. Harbor a negative attitude about budgeting from the outset, and the chances of creating a good budget are sure to be significantly diminished. Instead, consider the creation of a budget to be a positive move toward creating a helpful business tool, not a hurdle.
You may also experiment with different types of budgets. Budgeting on the accrual basis to estimate net income may be beneficial for some companies, while other companies may want to focus on budgeting for cash flow. Some organizations may actually want to have two budgets to track both of these key financial performance measures. Either way, everyone in your organization needs to be on the same page when it comes to the goals of your budget.
2: Know Your Organization
It is important to understand the risks of your organization and the industry in which your business operates. For example, if you operate in an industry that is significantly seasonal in nature, an annual budget will probably need to be broken down into a quarterly, or even monthly, approach.
In addition, you should be aware of pending changes in regulations. For example, have you considered the effects the recent changes in FLSA overtime regulations will have on your organization? What changes are coming related to health care? These are the kinds of factors you will need to understand before diving into the creation of your budget.
You should also compare your organization to industry standards. There are tools and resources your CPA can provide that can assist with industry comparison efforts. Obviously your organization is not exactly like every other one in your industry. However, if you can identify areas in which your results vary significantly (and the reasons for those variations), you can make better decisions as they relate to your spending.
Overall, it’s a good idea to identify the most substantial threats to productivity within your organization and the financial impact of such threats.
3: Build the Right Budgeting Team
“If you build it, it will come together.” Okay, not quite the same line Kevin Costner’s character heard in Field of Dreams, but there is great importance in building the right team to create your budget. A budget should not be created by one person. If certain groups of employees are going to be held accountable for the budget, then they should have some influence on the creation of the budget.
While we typically restrict budget creation to members of management, maybe it is time to think outside of the box and involve individuals from the factory floor, IT, quality control, or purchasing. They may be able to bring fresh perspectives to the budgeting table.
For example, a factory employee may be able to help identify when equipment will need to be replaced or overhauled. And who better to identify when potential repairs to delivery vehicles might arise than those who actually drive the delivery vehicles every day?
4: Be Realistic
A budget isn’t truly effective if it is designed toward a certain “targeted” number. The budget should be a true guide developed based on past actual results and future projections. If you create an unrealistic budget and provide it to people, they will likely scoff and dismiss it as “unattainable.”
Rather, you should analyze past financial results (up to five years) as a starting point. What are some costs that are fixed and inevitable? Those can be entered first. Then you can look at accounts or line items that have fluctuated more drastically over the years. What caused this fluctuation? Were there one-time expenses? Can these fluctuations be controlled? Using past information and adjusting for predicted variances in the upcoming year provides a more concrete basis for establishing budget numbers.
5: Be Conservative
As part of your budget, you should factor in some level of the “unknown.” As I tell our staff during audit training, “You don’t know what you don’t know, but you know that you don’t know something.” In other words, there is always some element of a project that is unexpected. It’s what makes that project unique. If we knew all the anticipated costs and factors of a project, it wouldn’t be a project.
It is up to you how you factor this in. Should you have a line item in your budget for “contingencies,” or should you “round up” each individual line item to factor this in? Whichever way you decide to go, you definitely need to factor in the element of the unknown.
In addition, consider the need to plan for future years. Economic downturns are inevitable, so in a strong economic year you should not only create a balanced budget, but start building up a cushion for the anticipated rainy days.
6: Be Flexible
Medical studies show that as we get older, our bodies lose their natural flexibility. That doesn’t have to be the case with your budget.
It is okay to amend your budget during the year. In fact, it should be amended, maybe several times, during the year. Constantly revisiting your budget is a very healthy exercise for your organization’s well-being. Wait until the end of the year to compare your actual results to the budget, and you will be way behind the curve.
If you find certain line items that are in danger of going over budget, look for other line items that are coming in below budget and “borrow” from those items to maintain the same bottom-line goal you started the year with.
7: Be Detailed
“Go the distance.” In other words, the more detailed your trial balance is, the more effective your budget will be. Now, there is a fine line here. Obviously you don’t want to have a separate line item for each check you write, but the more detailed you can get, the better. And that starts with tracking expenses according to the way your chart of accounts is set up. Is it time for a fresh look? Should some things be grouped together? Are some line items really housing several different types of measurable expenses? These are all questions you should answer when it comes to your trial balance.
For example, some organizations may be fine with a line item called “payroll.” But other organizations will want to break that down by division or employee position type. Similarly, instead of having a line item for “employee benefits,” it may be more beneficial to have a line item for each type of employee benefit (health insurance, retirement benefits, sick and vacation pay, tuition reimbursement, etc.).
When it comes time to analyze why some line items were out of whack compared to the budget, this can help ease the pain.
8: Be Aware of Financial Relationships
Sometimes you cannot change only one line item in your budget. It’s like going to the store and buying a flashlight. You have to pick up batteries, too, right? Or when you grab peanut butter, you have got to grab that jar of grape jelly.
As a result, sometimes you have to be careful changing one line item of your budget without analyzing the effect of that change on other line items. For example, you find out that you are going to increase your workforce by 10%. Instead of just increasing the payroll line item by 10%, you will want to be sure to increase employee benefits, payroll taxes, and other items that are directly related to payroll.
Similarly, if you think you can just bump up your bottom line by increasing sales by 10%, don’t forget to also increase variable costs related to sales (costs of goods sold, commissions, taxes, freight, etc.).
9: Utilize the Right Tool(s)
Most accounting software has a budgeting tool built directly into it. So if you are frustrated with your Excel budget, take a step back and check whether your current software has a tool that you could utilize to assist.
This may lead to increased efficiency, since you can link your results to multiple prior years and analyze the current-year budget with a simple click of a button. Let your software work for you!
10: Share it!
Last of all, an organization’s budget shouldn’t be a secret. Certainly, there are instances when some financial information should be kept to a limited group. However, organizations will find that increasing the number of people in that group will lead to greater transparency and potentially some increased feedback and beneficial communication.
Further, the budget to actual could be used as an incentive for employees to increase their division’s productivity and limit spending. An organization could create a friendly competition between divisions using the budget as a tool. You could even come up with rewards to employees or groups of employees based on actual results or for input that’s used to help keep their divisions under budget when it comes to expenditures.
The more you can empower and engage your employees, the better for your organization. Using the budget as an incentive tool could be a great leap forward.
As mentioned at the beginning, all 10 of these tips may not pertain to your organization. I hope that by reading this article you garnered a few ideas which can directly help and that your awareness has been heightened regarding better ways to budget. Many of these tips could also be applied to a personal budget. Whether you use these suggestions in your business or personally, I hope you have a new viewpoint on the potential impact a good budget can have on your overall operations.