Business finances are vital to every business. A budget helps businesses make operational and strategic financial decisions for profitability and growth. Every business needs finances to carry out daily operations and invest in growth opportunities.
Due to competing financial needs, a budget gives businesses insight into how much revenue will be generated and expenses will be incurred. These steps can help your business create a practical budget.
Steps to create a comprehensive budget
Identify business expenses
Some expenses re-occur monthly, quarterly, or annually, such as rent, utilities, office cleaning, and insurance. Other costs, such as office equipment repairs or office space renovations, may be one-off. When creating a budget, estimate recurring expenses based on historical costs and other adjusting factors, such as expected price increases due to inflation. Include cost estimates for contingencies to cover one-off unexpected expenditures.
The Canada Revenue Agency (CRA) allows you to claim some business expenses when filing your T2 Corporation Income Tax Return. General expenses you can claim are insurance fees, property taxes, freight, travel and transportation, professional fees for legal matters and accounting, maintenance and repairs, and bank interests and charges.
Categorize business costs
Business expenses may be fixed or variable. Fixed expenses are costs a business incurs in the same amount periodically. These expenses stay the same frequently and do not vary based on any business activity. An example of business fixed expenses is rent and utilities. Variable expenses, on the other hand, vary. An example of a variable business expense in a production company is the cost required to acquire raw materials and inventory to produce final goods. The more inventory a business purchases, the higher the cost of goods the business will incur.
Create pro forma financial statements
Budgeting for revenue and expenses allows businesses to create comprehensive forecasts for balance sheets, income statements, and cash flow statements. A balance sheet budget shows the expected assets, liabilities, and equity of a business at a given period.
An income statement budget forecasts the total revenues, expenses, and profit margins that make up the business’s bottom line. The bottom line is how much profit a business retains after using its revenues to offset total expenses and taxes. Your income statement budget should take into consideration the timing of revenue and expenses. Generally, businesses are required to use the accrual method of accounting to report their income. An exception is allowed for farmers, fishers and self-employed commission agents who can use the cash method or the accrual method.
If your business uses the cash accounting method, you can recognize expenses on your income statement in the period actual cash is paid for those expenses and income when you receive it. On the other hand, an income statement budget using the accrual accounting method records expenses when they are incurred and revenue when they are earned.
Every business needs cash to run smoothly. You need cash to pay vendors, settle debt, pay salaries and wages, and expand operations. A direct cash flow budget allows you to analyze all sources of cash inflow such as sales, interest or dividends earned from investments, and other income.
A cash inflow budget provides insight on how much income your business can generate to fund cash outflows. Using a balance sheet and income statement budget, your business can create an indirect cash flow statement showing cash from operating, investing and financing activities. Your business’s operating cash flow is derived from operational activities, while investing cash flow is any cash inflow or outflow from investing in other companies or capital. Cash flow from financing activities are cash related to debt, financing from shareholders, or other sources of financing.
Best practices for business budgeting
Track revenue and expenses
Consistent record-keeping helps business owners identify revenue and expense trends. Tracking expenses helps create a realistic estimate of business costs in a financial budget. Recording and tracking total sales also helps businesses estimate total revenue and profits.
Use a flexible budget
A flexible budget allows businesses to adapt and remain agile in planning. With a flexible budget, a business can increase or decrease its planned budget based on more recent business and economic insights.
Carry out variance analysis
Creating a budget is only one step of an effective financial planning process. To understand the key cost drivers, businesses need to conduct a variance analysis, comparing the original budget to updated forecasts and actual financial results. A variance analysis can provide insights into expenses over or under budget.
Use effective budgeting tools
Accounting and finance technology provides seamless processes for businesses to record and track income and expenses, which allows for a more effective budgeting process. Accounting software such as QuickBooks, Xero, and Wave help businesses create effective budgets.
At DW & Associates Chartered Professional Accountants, we provide accounting and financial planning solutions that help businesses create effective budgets. Contact the team to learn more.
