3 Budgets Your Business Needs in 2023
Budgeting is a crucial aspect of running any type of business. Without a budget, expenses can easily spiral out of control and you can leak profits.
As part of the new year, it’s essential to sit down and ensure that your business is budgeting properly. Specifically, your business should have at least three types of budgets in 2023 (and beyond). But first, let’s look at some budgeting basics for businesses.
Budgeting Basics for Businesses
Budgeting makes an educated guess about the future of your business’s finances. It looks at past data and factors in anticipated changes to predict your revenue and expenses in the coming months or year.
Budgets can help your business prepare for best, expected, and worst-case scenarios.
3 Types of Budgeting Your Business Needs
Businesses can have many different budgets, but three of the most important ones are: realistic, stretch, and worst-case scenario. These three budgets will help you plan and prepare for a variety of situations that your business may face.
1. Realistic Budget
Every business should have a realistic budget. A realistic budget will help you keep costs under control by forcing you to look at your expenses, which in turn will help you improve operating efficiency and ensure you’re spending money at the right times and in the right places.
Essentially, a realistic budget is what you think will happen based on past performance and data, factoring in changes in the marketplace and any internal changes.
Creating a realistic budget is a straightforward process.
Examine Past Revenue
The first step to creating any budget is to look at all of your revenue sources. Adding up all of the income coming into your business will help you understand how much income flows into your business every month.
It’s important to remember that you’re looking at revenue and not profit. You’re adding up all of the income your business generates before expenses.
Once you have a list of your income sources, you can calculate your monthly income. For budgeting purposes, if possible, you want to calculate your income for multiple months – 12 months is ideal.
If you have 12 months of income data, you can get a clearer picture of how your business performs throughout the year and identify seasonal patterns.
Subtract Fixed Costs from Revenue
Once you have all of your income data, you can begin subtracting your fixed costs. These are costs that generally don’t change from month to month, such as:
- Telephone and internet
- Payroll – Other than direct labor (although this can fluctuate if you’re business is seasonal or you’re planning to add headcount)
Every business is unique, so you may have other fixed expenses that you will need to include here.
Once you have a list of your fixed expenses, you can subtract them from your income.
Calculate Your Variable Expenses
Variable expenses are those that change from month to month, depending on your usage. These can include both essential and discretional expenses, like charitable contributions.
Examples of variable expenses include:
- Raw materials
- Direct labor
- Repairs and maintenance
- Truck expenses
Although these costs may vary, you will likely notice a pattern when looking at data over the previous 12 months. For example, you may need to replenish office supplies every 3 months, and the costs may be similar each time.
If you have enough data, you can estimate or average your variable costs for budgeting purposes. These expenses will also need to be subtracted from your revenue.
Set Spending Goals
Now that you have a clearer picture of your income and expenses, you can set spending goals. Setting spending goals will help your business control its costs and stay on the road to profitability.
Of course, this is a simplified version of creating a realistic budget. You may have other factors that you need to incorporate into your budgeting process.
For example, you may want to convert your budget to a cash flow budget to identify when cash will be tight, so you can plan for ways to improve cash flow during that timeframe.
2. Stretch Budget
Creating a stretch budget is more of a soft science. These budgets are complex and often subjective, but they help your business plan for the future.
Stretch budgeting is all about setting ambitious goals or targets that motivate teams to work harder and more efficiently. Essentially, you’re planning for a scenario where your business exceeds estimates.
Stretch budgets are a reach but possible. Consult with management and leadership to determine what they think may be possible for stretch targets.
For example, what would revenue look like with a stretch goal? What would the business need to potentially reach that goal (e.g. increased staff, new equipment, additional space, etc.)?
Stretch budgets can help motivate teams and facilitate growth, but it’s crucial to ensure that you’re setting realistic and attainable goals.
3. Worst-Case Scenario Budget
A realistic budget looks at what you think will happen, and a stretch budget looks at the best-case scenario.
But what if the worst happens? For example, we fall into a recession and sales dip 20%. That’s where a worst-case scenario budget comes into play.
A worst-case scenario budget will help you know what adjustments should be made in a disastrous scenario.
When creating this type of budget, outline which triggers would cause you to take action. For example, if your revenue falls below a certain threshold, you may need to lay off X number of employees and talk with your key suppliers and vendors.
When planning for these triggers and actions, make sure that you also consider how they will affect your business in the long run. For example, if you downsize your staff, you may lose talent that can be difficult to replace in the future.
Worst-case scenario planning involves:
- Analyzing your expenses to determine where you can cut costs without further hurting the business.
- Identifying how much profit your business can run off of.
- Determining your cash runway, which is the number of months until your cash runs out.
Most businesses have good and not-so-good cycles. Having a worst-case scenario budget will help you prepare to weather the storm until the sun comes out again.
Having realistic, stretch, and worst-case scenario budgets will help you prepare for the future and have a plan for your finances in the best-case, worst-case, and expected scenarios.
For some businesses, budgeting regularly can ultimately mean the difference between growth and shutting down operations. If your business lacks historical data, industry data can help fill the gaps and help you create a relatively accurate budget. Over time, you will accumulate the data you need to create more realistic and reliable budgets.
To learn more about budgeting for your business or to schedule an appointment, click here.