The Definition of a Budget
What is a budget?
A budget is a forecast of revenue, expenditure and profit. Most budgets are revised annually.
What does it achieve?
There are two (often overlapping) reasons for producing a budget. One is to persuade potential investors that your company is a good bet. The other one is to plan your business finances – how much money do you have and how do you plan to use it? How much revenue do you need to generate to achieve your target profit? Is your business plan viable or does it need adjusting? In retrospect, did the year pan out the way you planned, or did something go wrong?
How to approach a budget
First, find out how your accounting software deals with budgets. It’s far more efficient to use the same package for accounting and budgeting. Next, meet your accountant to plan how to structure the budget. Arrive prepared, with a chart of accounts and a list of informed questions. Take copious notes.
Traditional budgets are very difficult for start-ups and firms with a short history, because there is little or no historic data. Revenue is particularly problematic, because no matter how carefully you have planned, it’s impossible to predict the future. There are two main approaches to budgeting:
The projections approach
Here you enter projected costs and projected revenue, and calculate projected profits from these. This is a reasonable and rational if the company has several years of relatively stable history to project from. If it is a new company, such a budget is likely to become an exercise in denial and wishful thinking.
The required profit approach
An alternative method is to enter projected expenses, and then calculate how much profit you require, and how much you think you can actually generate.
Eventually this should be enough to pay your salary and provide a return on your investment in the company. However, it might be realistic to plan for a loss in the first year or two, and only a small profit for a year or two thereafter.
Having settled on
A budget is a forecast of revenue, expenditure and profit. Most budgets are revised annually.
What does it achieve?
There are two (often overlapping) reasons for producing a budget. One is to persuade potential investors that your company is a good bet. The other one is to plan your business finances – how much money do you have and how do you plan to use it? How much revenue do you need to generate to achieve your target profit? Is your business plan viable or does it need adjusting? In retrospect, did the year pan out the way you planned, or did something go wrong?
How to approach a budget
First, find out how your accounting software deals with budgets. It’s far more efficient to use the same package for accounting and budgeting. Next, meet your accountant to plan how to structure the budget. Arrive prepared, with a chart of accounts and a list of informed questions. Take copious notes.
Traditional budgets are very difficult for start-ups and firms with a short history, because there is little or no historic data. Revenue is particularly problematic, because no matter how carefully you have planned, it’s impossible to predict the future. There are two main approaches to budgeting:
The projections approach
Here you enter projected costs and projected revenue, and calculate projected profits from these. This is a reasonable and rational if the company has several years of relatively stable history to project from. If it is a new company, such a budget is likely to become an exercise in denial and wishful thinking.
The required profit approach
An alternative method is to enter projected expenses, and then calculate how much profit you require, and how much you think you can actually generate.
Eventually this should be enough to pay your salary and provide a return on your investment in the company. However, it might be realistic to plan for a loss in the first year or two, and only a small profit for a year or two thereafter.
Having settled on