Updated June 2, 2021
A few years ago I wrote an article about why it’s important to do both strategic planning and budgeting. Today, let’s look at what is involved in an annual budgeting process.
The four basic components to the annual budgeting process
Revenue forecast
Baseline budget
Strategic investment portfolio
Profit allocation
The Revenue Forecast
The reason most people don’t do a revenue forecast is because of the uncertainty of trying to predict future sales. That uncertainty is pronounced in small businesses – though revenue starts to get more predictable as a second stage business, and that’s why a revenue forecast starts to become a good idea. But a poor revenue forecast is better than no forecast at all, and you’ll get better each year you do them. (Warning: if you have a poor forecast, do not rely on it for major spending decisions!) If you just end up with a range of “between $1.2MM and 2.0MM” or an observation of “our forecast only gets us to 40% of this year’s revenue level,” those are still useful in charting your strategic course.
The Baseline Budget
The baseline budget has all the costs that are involved in continuing your business. The easiest way to start to come up with the baseline budget is to take last year’s budget and replicate it. I suggest you group expenses into meaningful categories – it’s more useful to know your combined spending on rent, insurance, utilities, and other basics is, say, 30% of the budget, than to have each of those items listed separately. (Here’s a quick video overview on the baseline budget breakdown)
The Strategic Investment Portfolio
The strategic investment portfolio comes out of your strategic planning. This is the investments needed to accomplish the goals you’ve set. That information should come from business cases you do for each of the major goals you have. If you’ve never done a business case, or aren’t sure if you’ve got them dialed in enough to be useful, send me an email [hyperlink] and we can set up a time to talk it through.
Profit Allocation
Finally, the profit allocation divides the profit that’s left over into three buckets. You start with how much is actually free and available. From there we get the three buckets of baseline expenses, how much is reinvested in the business, and the distributions.
Remember that these steps can be adjusted to be simpler or more sophisticated for your business. To turn an old phrase…it’s the budgeting, not the budget, that matters.
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