Every business, whether small or large, needs a way to track its expenses, revenue and profits. “Budgets are really important for both internal and external (reasons),” says Joseph Fahey, director of business succession planning for PNC Bank. Budgets help owners and executives make informed decisions about purchases and sales. What’s more, maintaining an effective budget can be used to attract investors or secure business loans.
Most businesses have more than one budget. In addition to an overarching master budget, they may have budgets for specific needs such as labor or capital. Operating budgets and cash flow budgets help track the current monthly, quarterly and annual status of an organization, while a budget within a strategic plan may forecast three to five years ahead. Some businesses also keep a static (or fixed) budget that does not fluctuate based on revenue or sales.
[See: 10 Best Budget Apps for 2019.]
“These are all pieces that are intertwined,” says Doreen Remmen, chief financial officer for the Institute of Management Accountants, the association of accountants and financial professionals in business, which has 110,000 members globally.
Here are common types of budgets used by businesses:
— Master budget.
— Operating budget.
— Financial budget.
— Cash budget.
— Labor budget.
— Capital budget.
— Strategic plan budget.
The Best Budget Types for Businesses
While the degree of complexity can vary depending on the size of the business, here’s a closer look at eight common types of budgets.
Master budget. A master budget collects and aggregates information from a business’s other budgets. “For large, multi-division enterprises, a high-level master budget is created representing the company’s revenue and expense forecast for the coming year,” says Robert Morlot, managing partner of the consulting firm Clearwater Business Advisers in Florida. It provides a big-picture look at a firm’s expenses and revenues on a monthly and quarterly basis. In a larger organization, a master budget can be helpful for managers to see how their division fits into the overall business.
Operating budget. An operating budget may be what people usually think of when considering business budgets. This document estimates revenues and expenditures for a certain period of time. Organizations often compare their actual results to the operating budget as part of regular reviews. “Using the operating budget, managers can track their progress toward their stated goals and make course corrections as required,” Morlot says.
Financial budget. A financial budget looks beyond revenues and expenditures and folds in assets, liabilities and stockholder equity. This information is laid out in a balance sheet, which provides a clear vision of a business’s overall health. The financial budget can be of critical importance when seeking funding, an initial public offering or a merger.
Cash budget. Also known as a cash flow budget, this document estimates how much money will pass through a business in a given month, quarter or year. “Rule No. 1 is don’t run out of cash,” says Scott Fine, a professor of finance at Weatherhead School of Management at Case Western Reserve University. The cash budget helps an organization know whether they can meet their immediate obligations and if a loan or other financing might be required to pay for upcoming expenses.
Labor budget. Remmen says a labor budget is important for any business that has employees. It can be used to determine how many workers are needed to achieve the desired level of production and then plan for the payroll cost of those employees. Plus, a direct labor budget can be helpful in preparing for the expense of seasonal workers.
[See: 8 Big Budgeting Blunders — and How to Fix Them.]
Capital budget. A capital budget is how businesses plan for purchases of large assets such as machinery or a new building. It lays out not only the cost of the asset, but also the expected payback period and whether the potential return on investment justifies the purchase.
Strategic plan budget. It’s common for businesses to have a strategic plan that creates a vision for the future. However, not all of them include a budget. They should, Fine says. “Strategic plans … tend to be more conceptual in nature,” he says. Incorporating financial information provides a practical road map for how a business needs to grow in terms of sales and acquisitions to achieve its goals.
Static budget. Some businesses, particularly those with predictable sales and expenses, create a static budget. This budget doesn’t change throughout the year and can be used to spot variations between budgeted and actual line items. Many businesses find a static budget useful for evaluating sales performance.
Creating a Business Budget
While business owners can try to tabulate their own budgets, it may be easier with outside help. That said, don’t expect a tax accountant to be able to develop all the necessary financial plans.
“A lot of smaller businesses have the misconception that if they have a good accountant, that’s all they need,” Fine says. Many accountants are focused on recording what happened in the past rather than planning for the future. Fine says business owners may need to supplement their accountant’s work with a budget analyst or another financial planner who can identify potential opportunities and challenges that may arise in the future.
Companies that aren’t large enough to warrant a full-time chief financial officer may be able to get some assistance temporarily from retired executives. “There are a lot of baby boomers out there who used to be CFOs who would be happy to take a part-time gig,” Fahey says.
Remmen says business owners need to do more than select the right budgets for their organization. They also need to put some thought into their budgeting approach.
Here are four types of commonly used budgeting systems:
— Traditional budgets: A traditional budget is created for a period of time and uses the previous year’s numbers as a starting point.
— Zero-based budgets: With a zero-based budget, a business is starting from scratch. “(With this type of approach), we’re not going to rely on last year’s budget. We’re going to start from zero,” Remmen says.
— Flexible budgets: A flexible budget will change as the sales forecast is adjusted.
— Rolling budgets: This budget approach ensures an organization is looking a year in advance. As each month or quarter ends, it drops off the budget and a new month or quarter is added.
[See: 10 Ways to Save More in 2019.]
Business owners need multiple budgets, each serving its own purpose, and must choose between several ways to set up each one. While small business owners are juggling multiple responsibilities, they shouldn’t overlook the importance of creating the financial plans that will set up their organization for a successful future.
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8 Budget Types for Businesses originally appeared on usnews.com
