This Insights article was contributed by Caroline Montgomery, CPA.
A question that accountants often get is “If I’m showing that much income, where did it all go?” This question highlights the issue of not having a formalized budget in place (amongst other issues).
The effectiveness of a budget, like almost anything else, is determined by the effort and focus you put into it. The back-of-the-napkin approach simply will not suffice in today’s rapidly changing business environment. A robust budgeting process should be prioritized by small businesses and large corporations alike.
Generally, small businesses do not have the time nor resources to invest in processes or systems that large corporations can afford. A meticulous and intentional budget, however, is an exception to that rule. It only requires the willingness and focus of its users.
Determining what a budget is and how it fits into your organization should precede building and implementing one into your operations. The former is discussed below.
Budget vs Forecast:
All budgets should be closely aligned with the goals and strategic objectives of the company. Consequently, a budget represents where a business wants to get to by quantifying aggressive goals that are set for the fiscal year. If the company is in a growth phase, then the budget may reflect hitting a goal of X percent increase in top line revenue. However, if the business is maturing, the budget may reflect more focus on enhancing margins.
Forecasting, however, is a process used to determine if the budgeted goals will be met. In other words, forecasting assists with budget-to-actual analyses. Forecasting provides information to decision makers to determine if the business is heading in the right direction.
Both processes should be used in conjunction with one another and revisited, at minimum, on a quarterly basis.
Fixed vs Flexible Budgeting:
The two predominant types of budgets are fixed and flexible budgets. A fixed budget remains static irrespective of the activity levels of the company (i.e. whether the business is manufacturing 1,000 or 10,000 widgets).
A flexible budget uses variance analyses to determine if activity levels change and how does that affect the company’s profitability.
Each method has pros and cons. For example, a fixed budget is simple and easy to implement. However, if the business is experiencing seasonal or fluctuating revenues then a fixed budget may not provide as much value. Conversely, a flexible budget provides more accuracy but can be a complex, costly process.
Both types of budgets, however, assist in meeting general goals that many small-businesses have.
Budgeting fulfills various goals of the organization, including:
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