This article is part of a series of articles that will explain the key components of the financial and operational planning process for small businesses. This is the first article in the series and will explain the basics of the financial plan.
Budgeting: The basis for planning and control
A budget is a comprehensive financial plan setting forth the expected route for achieving the financial and operational goals of your business. Budgeting is an essential step in effective financial planning. Even the smallest business will benefit from preparing a formal written plan for its future operations, including the expected levels of sales, expenses, net income, cash receipts, and cash outlays.
The use of a budget is a key element of financial planning and it assists business owners in controlling costs. Business owners can compare actual costs with the budgeted amounts and take corrective action as necessary. Thus, controlling costs means keeping actual costs in line with the financial plan.
While all businesses engage in some degree of planning, the extent to which plans are formalized in written budgets varies from one business to another. Large, well-managed companies generally have carefully developed budgets for every aspect of their operations. Inadequate or sloppy budgeting is a characteristic of businesses with inexperienced management.
Benefits derived from budgeting
A budget is a forecast of future events. In fact, the process of budgeting is often called financial forecasting. Careful planning and preparation of a formal budget benefit your business in many ways, including the following:
- Enhanced management responsibility. On a day-today basis, most business owners focus their attention on routine problems of running their business. In preparing a budget, however, you (as the business owner) are forced to consider all aspects of their business’ internal activities and to make estimates of future economic conditions, including costs, interest rates, demand for the business’ products, and level of competition. Thus, budgeting increases your awareness of your business’ external economic environment.
- Assignment of decision-making responsibilities. Because the budget shows the expected results of future operations, you are forewarned of and responsible for financial problems. If, for example, the budget shows that your business will run short of cash during the summer months, you have advanced warning to hold down expenditures or obtain additional financing.
- Coordination of activities. Preparation of a budget provides you with an opportunity to coordinate the activities of the various functions within your business. For example, production levels should be budgeted to produce approximately the same quantity of goods that you budgeted to sell. A written budget shows you in quantitative terms exactly what is expected for each function during the upcoming period.
- Performance evaluation. Budgets show the expected costs and expenses for each function as well as the expected outputs, such as revenue to be earned or units to be produced. Thus, the budgets provide a yardstick with which each function’s actual performance can be measured.
Creating a financial plan can feel intimidating. If you’re like most business owners, you probably didn’t go to business school or have a degree in accounting. No problem. This series of articles will explain the basic elements that you need to include in your financial plan, to help you get off to a good start.
All business plans, whether you’re just starting a business or building a plan for an existing business, should include the following:
- Sales forecast
- Profit and loss statement
- Balance sheet
- Cash flow statement
Even if you’re in the beginning stages of your business, these financial statements can still work for you.
Fortunately, they don’t have to be difficult to create or hard to understand. All you need to start creating your financial plan is a few educated guesses about how much you plan to sell and what your expenses will be.
If you’d like help creating your comprehensive financial plan and understanding the related financial statements … we can help. We specialize in helping businesses create comprehensive financial plans, monitor their financial activity and understand their financial statements. So, if you don’t have the expertise or resources Click here to contact us!
For more on small business financial plans, check out Part 2 for an explanation of the sales forecast.