What is budgeting?
Simply put, budgeting is the process of creating a budget for an upcoming period. This is typically done annually (for the next year or multiple years), but many companies also prepare or revise budgets on a quarterly or even monthly basis.
A budget can have various forms, ranging from a simple overview of costs by category or department to complete financial statements, including the Income Statement, Balance Sheet, and Cash Flow Statement. Most budgets map out a company's estimated income and expenses.
In essence, your budget is your company's financial roadmap, ensuring that you'll fund your current and future plans and understand performance and cost drivers to make better financial decisions.
Budgeting helps you translate your business goals into a financial plan and consider business aspects and answer questions regarding your:
- Goals: What do you want to achieve? (e.g., top-line goals, margin improvements, etc.)
- Strategy: How will you achieve your goals? (e.g., entering new markets, increasing marketing spending, adjusting pricing, etc.)
- Metrics: What are your input and output metrics? (key drivers and KPIs of the business)
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Why is budgeting important?
Creating a budget is essential for any business, no matter its stage. There are multiple reasons why creating and managing a budget is crucial.
- Planning: A business budget is one of the main tools for planning. It helps you define clear goals, allowing the company to prioritize and focus on what's needed to achieve them. Then, determining and allocating the necessary resources to reach those goals.
- Transparency: A budget creates transparency for both internal stakeholders (a company's employees) and external ones (e.g., investors). Furthermore, preparing budget results in alignment within and across teams as it helps increase feedback and spark conversations regarding the different objectives and how they can be reached. This is why collaboration in budgeting is paramount - team members gain a better understanding of the business priorities when they know the budget and contribute to it.
- Accountability: Having your team or different teams and departments define their goals and budgets increases their responsibility and commitment to reaching these goals. It helps you track the business and individual teams' performances by comparing your estimated goals to your results (budget vs. actuals). Optimizing your actuals vs. budget could also be used as an incentive for employees to limit expenses and increase profitability as well as employee productivity.
- Financial health: Without having a budget that details your goals, objectives, and how you plan on reaching them, you won't be able to monitor the financial health of your business. Without planned goals and milestones, you can't determine whether your business performance is sufficient and sustainable or not. Accordingly, preparing and following a budget often results in better financial discipline as companies and their employees make more thoughtful decisions.
But where does one begin when it comes to budgeting and preparing for the budgeting season? Find out more in our article on how to prepare a budget for your company, or download our free Budgeting Survival guide.