Mastering the budgeting process

• Review your previous budget 

• Understand your income 

• Budget for fixed costs 

• Account for variable expenses  

• Set short-term and long-term goals 

• Communicate clearly 

• Refine the process 

Review your previous budget: What did your budget look like last year? Was it followed? Were there any surprises? Evaluate how things went and what could be improved.  This review will make budget forecasting much easier, as you’ll have a historical reference point. 

Understanding your income: This step involves some budget forecasting, as you’ll need to make informed predictions about your income for the upcoming period. You should identify your income streams and estimate the expected amount from each. If you have financing, such as venture capital, decide how much you’re willing to use. 

Budget for fixed costs: You can’t predict every expense, but you can plan fixed costs. These costs, also known as overheads, are typically consistent and not influenced by the business’s performance. 

Consider more variable expenses: Variable expenses can be adjusted, sometimes on short notice. Set upper limits for these costs and determine the minimum they can be reduced to. Marketing budgets, team perks, and travel expenses are examples of variable expenses. 

Assign some short-term and long-term goals: Determine where you want your business to be at the end of the budgeting period and in the following years. Your budget should not only address immediate needs but also set you up for long-term success. Involve stakeholders from across the business and consider creating a 'rainy day fund'. 

Communicate clearly: Once your budget is finalized, communicate it effectively to your team. Ensure everyone understands their spending limits and any associated KPIs. Without clear communication, the budget will not be useful, as people won't know how to adhere to it. 

Refine the process: A budget is not a one-time task; it requires regular review and adjustments. If your financial situation changes, such as receiving unexpected funds, decide how to allocate them. 

Throughout each stage of the budgeting process, consider budget forecasting. Budgeting and forecasting are intertwined; forecasting is not about predicting the future but making an educated 'best guess' based on data and historical trends. Effective budget forecasting leads to a more informed budget. 

Budgeting Best Practice for Businesses

To ensure effective budgeting, follow best practices and avoid common pitfalls. 

Common pitfalls

• Not thinking strategically: Resist the urge to spend money as soon as it comes in. Consider long-term implications and ongoing costs to avoid financial trouble. 

• Underestimating costs: It's common for people to account for significant ongoing expenses like salaries or rent, but smaller costs can accumulate and often go unnoticed. These include expenses like heating bills, office supplies, and even your phone service. While it's not practical to itemize every minor expense in your budget, it's important to include these smaller costs. 

• Emergency manoeuvres: No budget is completely foolproof, and predictions can never be 100% accurate. It's essential to have a contingency plan for unexpected changes. For instance, if your agency heavily relies on a single client, you need a strategy for what to do if that client suddenly terminates your services. 

Effective budgeting techniques 

• Incremental budgeting: This is a straightforward approach where you take the previous year's figures, apply a certain percentage increase, and use this as the basis for the current year's budget. While this method is simple and easy to explain to the broader business, it lacks precision and is only viable if you have historical data to reference. 

• Zero based budgeting method: With this method, you start each budgeting cycle with a baseline of zero and require managers to justify every expense as though it's being considered for the first time. This approach can significantly reduce budgets, especially useful for businesses operating on tight margins. However, it can be very time-consuming. 

• Value proposition budgeting: Similar to zero-based budgeting, value proposition budgeting involves justifying each expense by the value it creates. Unlike the former, which focuses on cutting costs, value proposition budgeting centers on achieving specific goals. This method is less rigid but can be challenging to determine what is genuinely valuable. 

The Role of Technology in Budgeting

According to the CFO, the average finance employee spends around 75% of their time gathering data, which leaves less time for actual data analysis. This issue is exacerbated when relying on paper-based solutions or even tools like Excel. Software can significantly impact planning and budgeting processes. There are many technological solutions available, each with its own set of advantages for the budgeting process, such as: 

• Cloud-based Technology: Update your budget from anywhere, eliminating concerns about version control or compatibility issues.

• Data Visualization Tools: Use these tools to present and explain your data in a format that's easily understandable by various stakeholders.

• Collaborative Platforms: These platforms allow you to organize your budgeting and forecasting documents so that they are accessible to other team members. 
   

Take it further: Advanced Topics in Budgeting