Tips for creating an effective budget
Unpredictable factors and events can positively or negatively affect your business. An increase or decrease in clients, fluctuating income, competition, staffing issues, changing suppliers or new technology can make you change your business processes or shift your focus to different market niches, products or services.
All of this volatility can discourage a business owner from creating a budget. Really, how can a budget predict the unpredictable? It's true that budgeting for the future isn’t easy when there is constant internal and external change. However, a budget can still help your business grow, even if it’s aspirational at best; and with good practice you’ll create a budget that works for you.
Budgets are like navigation tools that break down your business goals into smaller milestones leading to your desired destination. Without a GPS, you can’t see how the road blocks and detours in your everyday business will steer you away from that destination. A budget allows you to see the complete roadmap, identify any changes and evaluate how much they have affected your plan.
We can’t predict the unpredictable. But we can train ourselves to create effective budgets that are current, relevant and keep us focused on our long-term goals. Here's how:
1. What are your business goals? Are they short-term or long-term? Do you have a percentage in mind for revenue growth? Should your business reduce debt or save for something? Write some goals and set target dates.
2. Start early. Your initial budget should start at the beginning of the calendar year or tax year – January or July – when you can make a fresh start for tracking your progress.
3. Break it down. Using the history from your Financial Reports, you can start breaking down your annual business goals into smaller and more manageable monthly and quarterly milestones.
4. Revise as needed. Budgets are dynamic documents. You should expect to adjust and update your milestones and goals as you go along. For example, you may decide to increase your spending budget for a marketing campaign. If you update your annual budget, you can see how these changes affect your long term goals.
5. Be realistic. Your business goals should be challenging yet realistic to achieve.
6. Look at the past. Your historical financial results provide the foundation for your projections. See our guide below on how to create budgets using historical totals.
6. Test it. Having developed your initial budget, you can start comparing it to actual monthly financial results. Highlight where you fell short or did better than expected by using a Budget Variance Report. If your income fluctuates, try a quarterly report.
7. Ask why. If your performance exceeded expectations, think about the reasons. Was it because of an unexpected windfall or new client, or are your goals too easy to achieve? If increased spending is revealed in an area of your business, look back and see if it’s a trend. Take a retrospective look at all the substantial positive and negative variances, and write some notes about the positive and challenging things going on in your business.
How to create a budget using historical totals
There are templates available for creating budgets in Excel and we sometimes build them for our clients. In our office, we usually prepare budget reports in Xero and MYOB.
Your accounting software can quickly produce historical totals for a date range. This will provide the foundation of data from which you can build a future budget. Check if your accounting software lets you generate a comprehensive budget to compare against actual performance during a selected period.
See this video tutorial which shows how to create a budget in Xero:
The Budget Variance Report in Xero
Having developed your budget, you can use Xero’s Budget Variance Report to generate a display of actual figures compared to budgeted amounts. Go to Reports > All Reports; Under Financial click Budget Variance.
The Budget Variance Report looks like the Profit and Loss Report with an Actual vs Overall Budget format by default. To quickly see whether or not your actual business performance is in line with initial budgeted projections, look at the Year To Date variance amounts and percentages. You can customise the layout by moving and grouping accounts, and save your preferred layout for future use.
Use this report each month from now to track your business performance against expectations. This will keep you focused on your long-term goals.