The budget is your financial roadmap to achieve company goals. When working with new clients, one of my first questions is, “Do you have an annual budget process?” From my perspective, this is an indicator of financial acumen. A budget expresses guideposts in dollars so a company’s managers can see if they are on track to meet expectations. In this article, I’ll break down the ways a budget can help you manage your business as well as the pros and cons of different budget methodologies.
A Strategic & Managerial Tool
Embrace your company’s budget as a tool that allows you to create alignment within your leadership team.
Often, the budget process will follow a strategic planning session. While big-picture goals are defined in the strategic planning session, the budget process metes out those ideas into defined financial targets. Big goals are crystallized into specific strategies for each department and financial metrics are assigned to each strategy.
In addition to clarifying company goals, the budget process is a gut check on whether the goals are achievable. Articulating goals is like creating an outline of the picture of the future, and the budgets that support that vision color in the lines — the picture of the future becomes much sharper.
Each department head is responsible for writing their own budget that aligns with company goals, and thus creates alignment within your leadership team. Knowing that they will be held accountable to the budget, department heads generally have much more buy-in than they would without going through the process.
Different Budget Methodologies
There are multiple types of budgets, but this article covers three: the static budget, the flexible budget, and a rolling forecast.
The static budget is one set of numbers that stays the same through the year. Set it and forget it. This is the most basic version of a budget.
The flexible budget sets a financial outcome dependent on the level of activity. In other words, the sales level or production level dictates the budget. Cost of goods sold and expenses are categorized as either variable or fixed. Variable expenses change based on the level of activity (for example, raw materials cost) and fixed costs are static over a relevant range (for example, rent). Therefore, if you sell 8,000 units the budget will look different than if you sell 10,000 units.
In a flexible budget, each line item would be coded based on whether it is fixed or variable. Having a flexible budget may not be logistically possible for all companies because it takes more work to set up.
Even if a company is working with a static budget, it should analyze whether the company’s actual performance is good or bad relative to the budget at the given level of sales. For example, in this COVID-19 era perhaps your restaurant revenue is down 20% from budget. As you review your performance, COGS may be considerably under budget (which you would normally celebrate), but are the COGS under budget enough even when considering the decline in sales?
The rolling forecast is a variation of the budget process that takes the current month’s performance and uses that to inform the budget for the same month next year. (For instance, September 2020 actuals will be used to budget for September 2021.) In this scenario, you are budgeting one month at a time. The actual results for one month inform the budget for the same month next year. This is my favorite way to budget because it keeps the topic alive within the leadership team and reinforces the message that each department is accountable for its results. I also believe this yields a more accurate budget. Further, it’s more likely that changes or adaptations to the process will happen in a more timely manner.
More Budgeting Basics: How to Build Your Budget
In the next installment of the Budgeting Basics series, I’ll cover how to build a budget for your brewery, winery, or cidery. I’ll also discuss how to use your budget as a tool for making key financial decisions and keeping your team accountable.
Stay tuned for Budgeting Basics: Part 2 — you can sign up for the Craftlab newsletter to be sure you don’t miss the latest articles.