Business Budget

Considering deploying Budgets in your business? This is your one stop-shop to get this done.

You have three types of solutions at your disposal:

STRATEGY ONLY: Read the article and do it yourself for free

STRATEGY + TOOL: Read the article and download the budgeting template to build your budget (and remove guesswork)

GUIDANCE: Schedule a call with a CFO who does this all the time

Download now

What Are Budgets

Budgets are key management tools in organizations where the managers need autonomy to operate and make financial decisions while staying within predefined financial limits (i.e. budgets).

Budgeting is fairly simple, yet there's a lot of confusion about it. Budgets are often confused with forecasts. They're related but different beasts.

Budgets give business owners the following benefits:

Management Autonomy
Management Controls

Do I Need a Budget?

Single Executive
Budgets are not very useful when the CEO (or business owner) is the only person who has the authority to spend money in the organization. If you fall in this category you might benefit from a forecast instead.

Multiple Executives
Organizations who have multiple executives (or multiple founders) with authority and ability to spend money on behalf of the company will benefit from a structured budget.

Budgeting Process Overview

Budget Owners

Identify the individuals in the organization who will require their own budget. These are the individuals who will be given the responsibility to operate within and manage the budget.

Normally, these will be Department Heads or Executives who take responsibility over an entire function in the organization such as Sales Function or Marketing Function, R&D, etc.

Resource Allocation

Determine the amounts that you're able to spend (Total Available Budget) and allocate this amount among the budget owners and functions (Budget by Function).

There are multiple methodologies for determining Total Available Budget and for determining Budget by Function.

Monitor & Manage

Establish internal control procedures to approve spending and ensure that all spending is within the budget.

In practical terms, this means that limits and approval flows need to be established before money is spent or an expense is incurred.

Track & Analyze

Track spending against the budget and analyze variances every month or quarter.

Structure your cost allocation practices in the accounting cycle to align with the budget structure so it's easier to compare actual spend against the budget.

Resource Allocation

Determining how much to allocate to each function is the most difficult of the budgeting decisions. So it's useful to break down the process into two steps:

Determine the Total Available to be Spent (Total Available Budget)
- There are many methods to determine this method, but you'll generally be ok if you go with one of two: Reserves Method or Percent of Revenue Method
Allocate Total Amount Available to Each Budget Owner and Business Function (Budget by Function)
- This part of the resource allocation process is also broken down into two steps:
  1. Determine Needs of Each Function
  2. Adjust "Needs" to Fit Total Budget

Total Available Budget

Reserves Method

This method is useful for startups with no revenue or for companies who want to invest a fixed amount in an experimental project.

The reserves method is simple. You look at your total Free Cash and divide it by the number of periods you need the funds to cover. The result is your budget for the period.

Free Cash = Total Cash in Bank - Current Liabilities - Other Cash Outflows.

Note: for pre-revenue companies who are using this method to determine the budget for an experimental project, the formula for Free Cash is reduced by the operational expenses required to operate the business until it is profitable or until additional funding is made available.

Operating Budget Example:
Unicorn LLC. has the following balance sheet composition:

Cash in Bank: $100,000
Accounts Payable: $5,000
Credit Card Balance: $3,500

Unicorn LLC has no revenue coming in the door and needs to last another 6 months to buy itself time until the next funding round. The company also anticipates an upcoming tax bill of appx. $5,000

Free Cash = $86,500
6 Month Budget = $86,500
Project Budget = $86,500 - (6 x 12,000) =
Avg. Monthly Budget = $14,400/mo

Action Plan
The company needs to ensure its operating expenses to fit into a budget of $14,400/month in order to last 6 months.

Project Budget Example
Unicorn LLC has same scenario as above and the company spends $12,000/mo on average and forecasts the same to be true for the next 6 months. It wants to invest in a marketing campaign to improve its customer growth numbers so it has an easier time impressing investors.

Total Project Budget
$86,500 - (6 x 12,000) = $14,500

Avg. Monthly Marketing Budget
$14,500 / 6 months = $2,416/mo

Action Plan
Unicorn LLC has enough cash to last for 6 months and invest $14,500 in a marketing campaign provided it does not exceed $12,000/mo in operating expenses.

Percent of Revenue Method

This method is useful for companies that are profitable and want to know how much they should allocate to each functional area of the business.

This method allocates a percentage of total revenue for the period as a budget available to be spent. It takes into account variable costs and profitability requirements to insure against losses.

This method requires that management of the company understands its own unit economics. Namely, management needs to understand its variable costs per sale.

This method requires that Revenue number be determined to be used in the calculations. Because Revenue fluctuates often, different businesses will choose different methods to establish the Revenue number. Here are a few methods:

Revenue Lag Method
- Use previous month's revenue to calculate the budget for the next month
- You can also use an average of the last 3 or 6 months revenue
- This method is a "safe" method but it has an inherent "lag" (hence the name)
Forecasted Revenue Method
- Forecast the next month's revenue and use it calculate the budget for that month
- This method is dangerous because if you miss the sales forecast you may end up in a loss
Recurring & Predictable Revenue Method
- If you have predictable and/or recurring revenue, then take this number and use it to calculate the budget for the next month orquarter
- This is the preferred method because there's no "lag" and it uses high confidence revenue numbers to base the budget on

Once the Revenue number has been determined, you will need to determine the percentage of revenue that you have available to allocate toward operations. The formula for this is as follows:

100% - Variable Costs % - Required Profit before Taxes % = % Available for Operations

% Available for Operations is the % of Revenue you have available to allocate toward operations of the business in the form of a budget.

This method can be a bit more complex to execute. To make sure you get it right you might want to speak to a CFO.

Budget by Function

Once the total available budget has been established, you will need to allocate the resources among various functions and budget owners.

There are 2 Steps in Allocation Resources to each function or spend owner:

Determine the needs of each function
Adjust needs to agree with total budget available

DETERMINE THE NEEDS OF EACH FUNCTION
There are a few methods to determine the needs of each function, but for ease, you can pick one of the following:

Historical Spend Method
- This method is useful when there is no fluctuation in spending from month to month or you're not sure what future spending will need to look like.
- This method simply requires you to check how much each function / budget owner has been spending historically, then you make small adjustments to that as deemed necessary.
- Example: Sales & Marketing department has been spending $25K/mo in personnel costs and another $5K/mo in advertising and another $2K/mo in S&M related software and tools. This historical spending would be the default budget with this method.
Forecast Method
- This method is useful when you have an operational forecast in place.
- It is the preferred method because it's forward looking.
- This method requires you to prepare a forecast for each department - generally you'd prepare an operational financial model for the entire business and use the expenditures allocable to a particular function in the budget.
- Example: Sales & Marketing department has been spending $25K/mo in personnel costs and another $5K/mo in advertising and another $2K/mo in S&M related software and tools. However, the Head of S&M Department needs to hire another sales person to achieve the sales targets - the cost of this individual would be another $5K/mo plus ~$5K/mo in commissions and incentives. The budget would be defaulted to the historical spend plus the additional requirements. This is the default budget with this method.

Note that a conversation and alignment with each department head is mandatory prior to finalizing the "needs of each function".

Once the amount per function / budget owners has been set, then you can choose to either further break up the budget into categories of spending such as personnel costs, travel, opex, etc.

ADJUSTMENTS TO FIT TOTAL AVAILABLE BUDGET
Once you've determined the needs of each department some compromises and tough conversations will likely need to take place because you need to adjust the default budget for each function to align with the total budget available.

Example: if each department has forecasted that they need extra funding than in previous months and the combined total for all budgets is, say $50K/mo and the total available budget is, say $$40K/mo, then reductions need to made where possible.

Preventing Budget Overages

Controlling spending is generally easy so long as Internal Controls are established

Authority Controls
- Establish policies and procedures that outline:
  - Who's allowed to spend money
  - How much they are allowed to spend
  - What approvals are required
Access Controls
- Limit access to bank accounts and credit cards to trusted individuals
- Establish credit limits on credit cards

Schedule a Meeting with a CFO

Guide to Business Budgeting and Resource Allocation.docx

26.7 KB

Corporate Resource Allocation & Budget - Reserves Method.xlsx

70.5 KB

Corporate Resource Allocation & Budget - Percent of Revenue Method.xlsx

70.5 KB