As the end of the year approaches, it’s time to start thinking about next year’s budget. However, you may be unsure where to start if you’ve never created a business budget before or if your company has grown significantly more complicated since last year. We’ve compiled a quick guide to creating an annual budget to help you get started.
the objectives of your annual budget
Before we get into the steps for creating an annual budget, let’s take a moment to discuss why creating a yearly budget is important.
- Avoid running out of cash.
The first and most obvious reason is that you want to create a budget to avoid running out of money. Your budget not only creates a plan to spend within your means but also tracks your spending so you can intervene if it deviates from that plan. This is one of the most important goals of your budgeting process, but it is not the only one.
- Gain insight into the direction of your company.
An annual budget is a form of planning. To create your budget for the year, you must first determine where you expect to be as time passes. This includes, in addition to avoiding overdrafts, planning for future growth, and making business changes.
- Determine what motivates your company.
To effectively plan for the future, you must first understand what factors influence your outcomes. As you work on your budget, you should think about your key performance indicators and how they affect your results. Website traffic or sales leads are examples of revenue drivers; as they increase, so will your revenue.
- Figure out what you can change to get results.
Once you’ve identified your business drivers, you can apply that knowledge to your budget to create various scenarios based on those variables. What would happen if you increased spending in an area that boosts a key driver? What would happen if you had to cut your spending instead?
Aside from avoiding a cash crunch, your budget is critical for answering these questions and better understanding your business.
what to consider before making a budget
Because your budget is for the entire year, you must forecast how your company will perform over the next twelve months. That’s why, before you begin your annual budgeting process, consider your plans for the coming year and how they might affect your income and spending.
- Think about upcoming business changes. While life may occasionally throw you (or the entire world) a curveball, chances are you have a pretty good idea of what you want to do in the coming year. Do you intend to release a new product? Increase the number of employees? Moving to a new office or going completely remote? All of these factors will impact your budget, whether it’s expected income from a launch, expenses from new headcount, or a change in rental status. Your annual budget plan should reflect your impact expectations.
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- Establish profit and margin targets. If your company is generating revenue or plans to generate revenue this year, you most likely have margin targets that you hope to meet. Similarly, if you want to be profitable, you’ll need to keep a certain margin in order to do so. Keeping these margin requirements in mind as you prepare your annual budget allows you to work backward from your goals to determine what you need to do to achieve them.
- Develop fundraising strategies. Fundraising expectations will have a significant impact on your available resources, whether you are raising a round or taking out a business loan. When creating your budget, think about how you’ll allocate the new funds and your spending if fundraising takes longer than expected.
how to create an annual budget
When developing your company’s budget, you must consider two components: inflows (the amount of money you expect to bring in) and outflows (the amount of money you wish to spend, whether on product development or day-to-day operations). As a result, the end result might look like this:
Let’s dig a little deeper into what each section means.
revenue. This is the revenue of your company. This usually refers to sales revenue, which will also be included if you have income from other sources (rent from property your company owns, licensing royalties, etc.).
You should include your annual recurring revenue (ARR) if your company sells subscriptions or services. This is the sum of your subscription contract payments divided by the length of the service contract. For example, if a client pays you $6,000 for a three-year subscription, your ARR for that client would be $2,000 ($6,000 divided by three years equals $2,000 per year). While this does not directly affect your financial statements, it is an important KPI to monitor if you are a software as a Service (SaaS) company.
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revenue cost/cost of goods sold (cogs) This is the amount you spend to create your product or service. For companies that sell physical products, COGS includes any costs directly associated with providing the software or services to your clients, such as the cost of hosting servers. For COGS, i.e., any costs directly associated with providing the software or services to your clients, such as the cost of hosting servers.
It is important to note that promotion costs, such as sales and marketing, are not included in COGS; these will be accounted for elsewhere.
profit after taxes. This is the amount of profit you make from your sales before any other costs or expenses are deducted. Subtract your COGS from your revenue to calculate your gross profit. The remainder is your gross profit.
While actual profits will be lower due to additional costs such as operating expenses and taxes, gross profits help determine how efficiently your product is created. As a result, if your gross profits are low, it’s a sign that you should look into ways to reduce your COGS or increase your revenue.
payroll operating costs. This category includes any costs associated with paying your employees. This includes, in addition to salaries, health insurance, paid time off (PTO), Payroll taxes, and the costs of any other benefits you provide to your employees.
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expenses for non-payroll operations This category includes any money you usually spend running your business that isn’t related to employee compensation. This includes everything from rent and utilities to marketing and research, and design expenses.
operating profit/loss. This is one of the essential budget lines because it tells you whether your normal business operations are profitable or not. Subtract your total operating expenses (payroll and non-payroll) from your gross profit to get this figure. If the number is positive, your company is making money overall. If the number is negative, you are losing money.
Most startups aren’t profitable for several years, so an operating loss isn’t surprising. This number, on the other hand, is helpful because it allows you to understand your company’s current operations and track whether or not it is following your plan.
net profit/loss. After all, expenses have been deducted from gross profits to determine your total income or loss. If you have no other costs besides operating and capital expenses, this may be the same as your operating income/loss. If you do, however (for example, if you owe state franchise taxes), your net income will be your working income, less any remaining expenses.
It is important to note that this is not necessarily your “cash burn,” as the financial budget, mainly if your books are done on an accrual basis, does not reflect the exact inflow and outflow of cash. The timing of when your customers pay you and when you pay your rent, for example, can all contribute to your actual cash burn. That’s why annual prepayments can be so beneficial to startup cash flows.
how to get numbers for your budget?
Now that you have the information needed to outline your budget, it’s time to figure out the numbers that will go into it. These figures are derived from your financial statements and budget forecasting.
financial reports
Your company’s financial statements are the starting point for gathering the information you need to create your budget. Each statement contains different information to assist you:
- Your balance sheet provides information about the state of your business at a specific point in time. It outlines your company’s current assets as well as its current liabilities (money you owe for credit card payments, outstanding invoices to vendors, etc.).
- A profit and loss (P&L) statement, also known as an income statement, shows how much money your company earned and spent during a given period. It allows you to examine your company’s trends, which can help you predict what will happen next.
- Your cash flow statement displays the cash inflows and outflows of the company. This is useful for calculating your cash income and analyzing your current spending habits.
budget prediction
When it comes to budget forecasting, no one ever gets it exactly right. As a result, you can take steps to make an especially informed guess. How?
- Make use of the best available data. Use your financial statements as previously discussed, and if you have any historical data, use that as a source of potential trends. If you don’t have any historical data, that’s fine; everyone has to start somewhere, and you’ll have more data to review next year.
- Look at trends and consider what’s changing (or not). Looking at the data from your financial statements and other sources, you may notice trends emerge – perhaps you’ve been steadily increasing sales at a specific rate, or your expenses in a particular area have been consistent. Once you’ve identified a trend, consider whether there’s any reason to believe it will change. If there isn’t, for example, if you don’t intend to hire more sales reps or change your spending in that area, you can reasonably expect your numbers to remain the same or similar.
- Estimate the impact of change using your trends. If you are making significant changes, you can extrapolate the impact using trend data. For example, if you have two sales reps and an average of 10 sales per month, you might estimate that hiring a third rep will increase your monthly sales to 15 sales.
are you unsure how to create your annual budget? we can assist you.
Even for experienced business owners, annual budgeting is a difficult task. Expert advice can significantly impact how effective your budget is and how quickly it is put together. If you don’t have a background in finance, you must seek assistance from someone who does.
Countick offers outsourced CFO services, so your business can call on an experienced CFO whenever needed. Working with Countick CFO Services is a low-cost way to get expert advice on creating an annual budget to help your company succeed. The Countick will teach you how to make confident financial decisions.
