written by Khatabook | December 20, 2021

What is the Importance of a Business Budget?

A business budget gives you a clear picture of your expenses and income. It helps you make crucial decisions like enhancing marketing, lowering costs, employing people, buying equipment, and improving efficiencies in other ways. It also specifies your company's financial and operational objectives. Thus, it may be considered an action plan that aids in resource allocation, performance evaluation, and plan formulation. Therefore, let's delve deeper into understanding the importance of a business budget and types of budgets. 

Did you know?

The USA has the most number of startups in the world (63,703) followed by India, with just 8,301 startups.

Relevance of A Business Budget

According to a Clutch poll, 61% of small businesses do not have a defined budget in place. You may not understand how your firm is performing if you don't have a budget.

  • Making a budget allows you to see how much money you have, how much money you've spent, and how much money you'll require in the future. 
  •  A company budget can help you make key decisions like reducing unnecessary spending, hiring more people, or buying new equipment.  
  •  If you run out of money, the business budget can help you adjust your business plan or prioritise your spending on different tasks. 

You can keep your firm out of debt or find ways to lessen the debt it already has with the correct budgeting plan. A detailed budget can also be utilised to get bank or other financial institution business loans.

What are the requirements of a Business Budget?

The basic method of creating a budget entails creating a monthly list of your company's fixed and variable costs and then deciding how to allocate funds to meet goals.

 Specialised budgets are frequently used by businesses to evaluate specific areas of operation. For example, a cash flow budget forecasts your company's cash inflows and outflows over a set period. Its primary function is to forecast your company's capacity to take in more money than it pays out. 

The majority of businesses have fixed costs that are unrelated to revenue, such as:

  •  The cost of constructing a building or office, as well as the cost of a mortgage
  •  Payments on a loan (if using debt financing)
  •  Insurance
  • Leasing a vehicle (or loan payments if the vehicle is purchased)
  • the necessary equipment (machinery, tools, computers, etc.)
  • Paystubs (if employees are on salary)
  • Charges for utilities such as landline phones and internet   

 Depending on the level of company activity, variable costs rise or fall. Here are several examples: 

  • Wages and commissions paid to contractors (for salespeople)
  • Utilities that rise in price as activity rises, such as electricity, gas, or water
  • Supplies of raw materials
  • Costs of shipping and delivery
  • Advertisement (can be fixed or variable)
  • Equipment maintenance and repair

What factors should be considered when making a Business Budget?

It's critical to keep your budget estimates reasonable. It's especially challenging if you're starting a new business and don't have any budget statistics from the prior year to use as a guide. In this instance, estimating expenses is usually easier than estimating income.

 The projections should be updated monthly with real statistics as the budget year advances, allowing you to assess the accuracy of your forecasts. Due to unforeseeable business conditions and shifting business and economic cycles, there are frequently significant variations between actual and projected revenues and expenses, such as: 

  • Getting or losing a significant client
  • Having to buy or replace high-priced equipment
  • Increasing the rent
  • An increase in competition when it comes to hiring people
  • Modifications to the tax code

Also Read: Income statement – Definition, Importance and Example

Importance of Business Budget

 A business budget has enormous importance, which can be explained as follows:- 

  • A business budget forecasts an organisation's revenue and expenses over a set period and serves as the foundation for key business decisions.
  • Specialised budgets are frequently used by businesses to evaluate specific areas of operation.
  •  Budgets aid in the understanding of the startup and operating costs and the tracking of performance. 
  • In most budgets, fixed and variable revenue and expenses are included.
  •  Control the company's finances to guarantee that it can meet its existing obligations, achieve its goals, make sound financial decisions, and ensure that it has money set aside for future projects. 
  •  It's critical to convey your company's objectives to your employees and to make it obvious that the budget allows you to achieve those objectives. Employees can focus on a quantifiable goal like earning Rs X in sales and spending no more than Rs Y in expenses to have the finances to grow into the Z market by the end of the year. 
  •  To assist the company meet its goals, a budget may even push employees to think outside the box for solutions to sales shortfalls or spending overruns. As a result, the staff is more cohesive, engaged, and devoted, reflecting positively on the organisation. 
  • If there are expenditure restrictions and responsibilities, and if they are exceeded, owners and department managers will think twice about their purchases. Disciplined spending, on the other hand, does not imply deprivation. The beauty of a budget is that it shows how the numbers are linked; how a reduction in another can offset any increase in one department. This awareness motivates managers to collaborate and reduce overspending while maintaining essential services.

What are the different types of budgets prepared in an organisation?

 There are multiple types of business budgets. These can be enumerated as follows- 

Budget of the Cash Flows:

Investors, stockholders, and other interested parties all want your business to flourish, but they must also defend their interests. So, if you want to grow your business, it's better to have a strong budget in place to get stakeholders on board with your objectives. When all parties are on the same page about the firm's goals and how to achieve them, it's much easier to track progress and collaborate to keep the organisation on track.

Budget of the Production:

Your production budget determines how much of each product you should manufacture to meet sales and inventory needs. This form of corporate budget aids in the determination of operational issues such as:

  • Work that is done directly
  • Direct materials
  • Overhead

You'll need the estimated number of units to sell (based on the previous period's data), the required amount of ending inventory, and the number of units in your beginning inventory to create a production budget (if applicable).

 Your production budget aids in determining the cost of production, which in turn aids in determining the product's pricing. Keep a tight watch on the budget for your project. Adjust your manufacturing budget accordingly if sales and demand rise or fall. 

Budget of Sales:

A sales budget is among the kinds of budget you might wish to explore. A sales budget forecasts your revenue and expenses, as well as how much you'll sell in a given time frame. Making a sales budget allows you to prepare ahead of time and make necessary modifications to your spending. To create your sales budget, you'll need to do the following:

  • Make a list of your company's services.
  • Make a price list for each offer.
  • To project, look at the sales numbers from the previous year (or period).

Having a precise sales budget guarantees that you have enough supplies and inventory to meet consumer demand.

Budget of Finance:

Make a financial budget to figure out how much money you'll need to meet your short and long term goals. Assets, obligations, and equity are all considered in a financial budget (components of your balance sheet). The financial budget of your firm can provide you with an overall picture of its health and stability. This budget form is very beneficial if you're looking for investment or considering an IPO (Initial public offering).

Budget of Labor:

Consider generating a labour budget if you have a staff or plan to hire them. Determine how many staff you'll need to meet a specific level of productivity with a labour budget. Your labour budget also aids in the planning of payroll expenses. A labour budget can help you allocate spending for seasonal workers and assist you with staffing planning. 

Static Budget:

Some businesses may adopt a static budget if their sales and expenses are predictable. A static budget does not alter over the course of the year. A static budget can be used to identify discrepancies and assess sales performance.

Sales volume or any other changes in the firm do not affect a static budget. A static budget may comprise the following sorts of expenses:

  • Fees for Software Contractors
  • Fees for subscriptions
  • Utilities and supply expenses Utilities and supply costs

In your static budget, include any expenses that remain constant (or fixed) across time.

Operational Budget:

An operating budget, also known as an operational budget, lists all expenses and income your company intends to incur to run its operations. Your operating budget specifies the funds required for your business to run smoothly.

Fixed and variable costs, revenue, and other expenses are all broken down in operating budgets. Like all budget kinds in business, operating budgets can vary based on the company and its operations. In most circumstances, your operating budget is made up of a few different budgets, such as:

  • Direct Materials
  • Sales
  • Production
  • Overhead
  • Direct Labor
  • General and Administrative expenses

Master Budget:

A master budget is a compilation of lower-level budgets prepared by various organisational, functional divisions. It takes data from financial statements, cash forecasts, and financial plans as inputs. Management teams use master budgets to plan the actions required to meet their corporate objectives. Senior management in larger organisations is in charge of producing numerous iterations of the master budget before it is finalised. Funds might be allocated for specific company activities when it has been assessed for the final time.

Smaller organisations frequently use spreadsheets to build their master budgets, but using effective budgeting software instead of spreadsheets reduces errors.

What are the components of budget?

Creating your first budget might be difficult if you're beginning a new business. Here are the components of a budget you need to know that are required for creating a budget:

  • Revenue

This is the amount of money you anticipate your company making from the sale of goods and services. The two key components of estimated revenue are sales prediction and the projected cost of products sold or services rendered. If your company is more than a year old, you can use your previous experience to estimate these components. 

If your company is brand new, you can look up the revenue of similar area businesses and utilise that information to generate some conservative revenue estimates. However, whether your company is new or established, it is critical to remain realistic to prevent overestimating.

  • Fixed Costs

A fixed cost is when your company pays the same amount for a specific expense regularly. Building rent, mortgage/utility payments, employee salary, internet service, accountancy services, and insurance premiums are all examples of fixed costs. It's critical to factor these costs into your budget so that you can set aside the exact amount of money needed to cover them. If your firm finances aren't working as expected, they can also be an excellent reference point to check for difficulties.

  • Variable Costs

This category comprises the cost of goods or services that can change depending on the performance of your business. Consider the following scenario: you have a popular product on the market. The next step would be to increase the production of that product. When you increase production, the costs of raw materials, distribution routes, and production personnel will all shift, so they will all be considered variable expenses.

  • Non-recurring expenses

These are one-time, unanticipated expenses that your company may face in any given year. Replacing broken furniture or purchasing a laptop are two instances of these expenses. Because these costs are difficult to foresee, there is no reliable way to assess them. However, it's a good idea to set aside some money for this category to be prepared.

  • Cash flows

This is the cash that flows in and out of the company. You can estimate it based on previous financial records and utilise that data to protect your profits for the year you're budgeting for. You'll want to keep track of how much money is coming in and when it is coming in. Knowing when your cash flow is highest will assist you in planning when to make large purchases or investments if your firm has a peak season and a dry season.

  • Margin/Profit Earned

Profit is the final budget component, which is calculated by subtracting expected costs from revenue. Profit growth indicates that your company is expanding, which is a positive indicator. You'll be able to decide how much to invest in each functional area of your company once you've estimated how much profit you'll make in a year.

How to make a Business Budget?

 Your business budget serves as a financial road map for your firm. When preparing a budget for your business, follow these steps to ensure your finances stay on track: 

  • Add up your earnings.
  • Make a list of variable costs.
  • Calculate variable costs.
  • Make provision for additional and unanticipated costs.
  • Examine your cash flow situation.
  • Make a budget plan.
  • When required, make adjustments.

Once you've created any types of business budgets you want, go over them again from time to time to make sure they're accurate and up-to-date.

Also Read: Gross Profit vs Net Profit – How are they different?

Conclusion

One of the most effective instruments for managing your company's resources is your budget. Tracking your company's performance versus its budget can provide you with valuable information that you can use to solve problems or capture new possibilities. In this article, we have explained the meaning of business budget, why it is important, functions of budget, budget components. We hope you are now clear about the concepts of business budget planning and different types of budget. 

To learn more about business budgeting, accounting and financial tips, subscribe to Khatabook.

FAQs

Q: What is the master budget?

Ans:

 A master budget is a compilation of lower-level budgets prepared by various organisational, functional divisions

Q: Give Examples of fixed costs

Ans:

Rent, Maintenance, accounting service bill, etc. are examples of fixed costs

Q: What are the different types of budget?

Ans:

Sales Budget, Finance Budget, Production Budget, Operational budget, Static Budget, Labor budget, cash flows budget and master budget.

Q: What is a business budget?

Ans:

A business budget is a spending plan based on your income and costs for your company. It determines your available capital, forecasts your spending, and aids in income forecasting. A budget can assist you in planning your business activities and serve as a benchmark for establishing financial goals. It can assist you in overcoming short-term challenges as well as long-term plans. 

Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.