Why budgets are important in business: 9 reasons
It’s a simple fact. You can’t effectively manage a business (small or big) without a budget. The problem is that starting and managing a budget sounds tedious and complicated to most business owners. Besides, you didn’t start a business to live inside of spreadsheets.
Here’s what you need to understand.
No money = no business
The only way to know for sure if your business has money is by properly managing a budget. A budget tells you how much you can pay yourself, how much you can invest, and where the weaknesses and strengths lie.
Oh, and we’re not just talking about startups and businesses that aren’t highly profitable yet. We’re also talking to the business owners whose budget strategy is to outearn their lack of a budget.
Is that possible? Yes.
Is that serving your business? No.
Over the next few minutes, we’ll discuss why budgeting is important to business.
What is a budget?
A business budget is a spending plan for your business based on income and expenses. A business budget identifies key numbers like profit, revenue, and available capital. A budget allows you to make financial projections based on past numbers. Without a budget, a business can make the mistake of spending money it doesn’t have.
Parts of a business budget
A business budget will include estimated revenue, fixed costs, variable costs, one-time expenses, cash flow, and profit. A profit and loss statement is a business budget's main component. The financial projections made from the P&L turn into a master budget. A master budget is a company’s central financial planning document. It includes the budget for the entire year, then breaks down into sub-sections.
Here are a few sub-budgets businesses can create:
- Operating budget: This budget focuses on COGs and other expenses. It’s used to predict how much a business needs to and can spend on operations to maintain profitability.
- Cash budget: A cash budget aims to regulate the inflow and outflow of cash. Businesses use cash budgets to ensure there’s enough money to pay expenses each week, month, and quarter. Businesses have access to many types of capital, but cash is always king.
- Labor budget: Labor is usually the most significant expense for businesses. A labor budget helps businesses align to industry standards for how much they should pay workers and the size of their workforce.
Why budget is important
So, why is using a budget beneficial?
If you’re the CEO (chief everything officer), you have a lot on your plate. We won’t lie to you. Setting up and managing a budget takes time that you may not have.
Read the nine reasons why budgeting is important to a business. Then, decide if those benefits are worth investing the time to set up and maintain a budget. Even if that means making sacrifices along the way.
Hopefully, your answer will be “Yes.”
Improve decision making
Let’s start with the main reason why budgeting in business is essential. To run a successful business, you need to make good decisions. To make good decisions, you need a predictable environment. A budget is the foundation for creating a predictive environment for decision-making.
- Preparing for an emergency is a decision
- Attracting investors is a decision
- Hiring new staff is a decision
- Making large capital expenses is a decision
The question is, “Is it the right decision for my business?
A budget will help you answer that.
Prepare for emergencies
What should you do with leftover cash/profit? It’s tempting to spend surplus income on business growth or take dividends. However, it’s smart to establish an emergency fund and slowly add to it. An emergency fund is money set aside for unplanned expenses. There’s no way of knowing when these expenses will happen or how much they’ll be, hence the term “unplanned.”
This is where proper budgeting comes in.
A business budget can help you prepare for emergencies in two ways:
- Give you a target for how much you need in your emergency fund
- Help you determine how much you should save each month
Before an investor puts money into your business, they’ll want to understand your financial position. If you’ve seen the show Shark Tank, you’ll recall a familiar scene. A business owner dialogues about how much their friends love their product, how passionate they are, and so on and so forth. After their schpiel, one of the Sharks will say, “That’s great, but show me the numbers.”
Minus any theatrics, investors that look at your business are the same way. Documenting your budget from day one is important to give inventors a complete picture of where you are and where you came from. They’ll also want to see your budget projections for the future. This can help them determine how much money they should give you.
The obvious reason investors want to see a budget is to answer the yes or no question of, “Is this business worth investing in?” However, your overall financial sense greatly matters in your “investability.” You can have all the passion, expertise, and leadership in the world. If investors doubt your ability to track and spend their money properly, they may say no.
The main factor in your business pricing is the value of your product and service. However, many businesses make the mistake of undervaluing their product. They only factor in the direct costs of producing their offer. You must also factor in other costs to succeed as a business owner. Marketing, taxes, and, most importantly, paying yourself come to mind.
There is a sweet spot for your pricing that matches your customer satisfaction and your business goals. Metrics in your budget, like your profit margin, customer LTV, and fixed costs, can help you find it.
Set and track internal goals
Your business strategy and business goals are always aligned in a successful business. This means that a budget strategy defines strategic internal goals, and strategic internal goals define a budget strategy.
What are internal goals?
Internal goals are goals and deliverables that organizations track and strive to meet through internal operations. When creating internal goals, you need to factor in the budget to determine how much budget a given piece of your business needs to reach those goals. As your budget increases, do your goals increase, too? As your budget decreases, do you lower your expectations?
Manage recruiting and staffing costs
Employees are the lifeblood of your business. Whether hiring your first employee or growing a sizeable organization, you need a recruiting and staffing budget.
- Staffing budget: Money allocated towards full-time employees, temporary labor, and independent contractors.
- Recruitment budget: Money allocated toward attracting the attention of and hiring new staff. The two biggest recruitment costs are advertising and candidate assessments (interviews).
As a business owner, financial manager, or HR professional, you should align with a higher-level budget and internal metrics. You can assess how much you spend on staffing and recruitment from the top level. You can then use a budget to drill even deeper into the success of specific campaigns. You can use a budget to drill into the profitability of specific departments. Lastly, you can use a budget to determine how much new staff you can hire in a given period.
Track debt management
Let’s track back to the first part of a business budget, revenue. Part one of a business budget is adding up all your projected revenue sources. We’ll subtract all of your projected expenses to get your projected profit. One of those expenses, which many business owners ignore, is debt repayment.
You can manage your business debt within your budget by creating a business debt schedule. A debt schedule is a table that lists monthly debts in order of maturity.
Plan for capital expenses
Capital expenditures are purchases of goods or services that are recorded or capitalized on a business’s balance sheet. We won’t get into that now, but capitalizing is a process where a company spends money and delays the recognition of an expense. Deciding when and how much to invest in capital expenses is critical to growing a business. A “CapEx” budget can help answer those questions.
Ease tax preparation
Don’t wait for tax season to start planning and budgeting for taxes. As your business makes money, you’ll need to stock away savings to stay on top of your tax payments. As a business owner, tax preparation isn’t a once-a-year thing. Businesses must manage quarterly estimated tax payments, file sales, complete payroll tax returns, and issue W-2s or 1099s if the business has other employees or contractors.
You can automate some of this work by using business tax platforms like ComplYant, which provides custom tax deadline reminders, helps businesses budget for taxes, and is user-friendly for entrepreneurs and small businesses.
Why is using a budget beneficial for business?
Managing a business budget isn’t an administrative task that gets checked off a few times a year. It’s an integral part of growing a successful business. Aligning your budget with your business goals allows you to build out your budget with a strong view of business goals and objectives.
If you run a small business or a startup, you may think this stuff is for “bigger” businesses. The sooner you start a budget, the sooner you can understand the heartbeat of our business. If you need help keeping track of your business’s heartbeat, use a ComplYant to take the guesswork out of tax budgeting.