What to Understand about a Business Budget

By Diane M. Calabrese / Published August 2023

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business budget hinges on care and discipline. The more routine and accurate the recordkeeping, the better the profile of the health and weaknesses of a business becomes.

      It’s not just the business owner who wants a ready picture of the business, but also parties ranging from banks to a new partner to a prospective buyer. A business budget must be balanced.

Balanced does not mean that there can be no debt. It means that the way the debt will be paid and its tug on the income stream must be part of the record.

A business can borrow, but to be successful it must borrow first and then spend. It does not have the same capacity the federal government does to spend and then borrow, and if really in need increase the amount of currency in the supply pool and use some of it.

The word “budget” has an origin that reaches to the Latin bulga—a bag or pouch. Moving through the French and English languages, the root yielded related words that meant bag, pouch, or purse or their contents, such as bouge in Old French. It’s an interesting legacy because the idea of keeping the “contents” of a business—the assets and obligations—in one place (a budget, from bag) makes sense.

From accounts receivable to trial balance, business owners know the purpose of a budget is to put the components of money coming in, going out, and in reserve into context or a well-ordered bag. At any point in time the business owner can use the record to obtain a trial balance, one that signals whether debits and credits agree. If they do not agree, there is an error.

With software programs that can prompt inputs and warn of categories that must be reconciled, is it still important to understand the components of a business budget? Yes.

Absent the understanding, money in and money out may balance, but the way that money flows in and out may not sustain the company. You can forget about growth if the company cannot sustain itself.

Fledgling businesses often use a cash method of accounting. When payment is received for a product or service, it is recorded.

An accrual method of accounting records payments expected. The record is entered when the sale is made.

By using an accrual method, an owner can evaluate seasonal patterns in sales volume and amount. The patterns can be used to make predictions and modifications.

There’s danger in accrual methods in that expectations can be built on sales that fall through or accounts receivable that are slow to pay or are never paid. In fact, software programs for budgeting provide the flexibility to dissect information from both a cash method and an accrual method.

With a budget in hand, an owner can plan and adjust as required to make a profit. The more precise the entries on incoming and outgoing funds, the easier it is to identify places for adjustment, when necessary.

What should be recorded in the compilation of business expenditures? Everything related to the business: rent/mortgage, utilities, phone and internet, insurance, employee expenses, contractors, office supplies, permits, licenses, dues/memberships/subscriptions, income taxes, travel, interest, bank service charges, postage, legal fees, accounting, and other.

And, if all is going as it should—the business is profitable—the owner should be taking a payment. That’s the “owner’s draw,” which gets recorded like everything else.

“Financial Management for a Small Business,” a 22-page participant guide available from the Small Business Administration (SBA.gov), offers an overview of what should be in a budget and the importance of a budget. It’s available at no charge in pdf format. From sample cash flow projections to sample profit and loss (P&L) statements, the training tool serves as both a primer and a refresher.

The SBA’s participant guide ends by stressing five key points, and we extract the essence of them here: Financial management begins with a budget. Orderly record-keeping is foundational to financial management. Cash flow analyses are a must to avoid surprises (and adjust before a surprise turns to disaster). P&L statements put a mirror to a business and reveal the truth (whether the business is profitable). A loan (financing) may be a need, but only if it can be obtained.

Without a meticulously kept budget, it may be impossible to know whether a loan is affordable. Put the emphasis on affordable because overextension is a good way to put a business on the path to ruin.

Refresh

Using software programs simplifies and speeds up the budgeting process. It also reduces errors. But software can encourage detachment unless an owner takes the time to use all the analytical options available.

It’s the same sort of detachment that comes from using software to do taxes. The time savings and enforced accuracy are wonderful, but time must be taken to understand what’s happening.

Large companies that employ a full-time accountant and CPA can rely on that individual to provide summaries and updates to leadership. However, in smaller companies where an accountant only reviews the books on a periodic basis, and the day-to-day work is done by an employee assigned to bookkeeping, the owner should set aside time for scrutinizing the budget.

In reviewing the budget, be sure that it’s sufficiently detailed (e.g., all expenses are being tracked) and that it’s not just the accounts payable and accounts receivable that get all the attention. Factors like allowances and depreciation should not be ignored.

Allowances might occur periodically because of discounts offered or returns by customers. They should be carefully recorded so their impact on the budget can be assessed.

Assets—anything a business owns that might be converted to cash if sold or collected on (receivables)—should not be overestimated. Estimating the market value of any item is difficult because the day of sale—not a projection—tells the tale. The bigger difficulty in valuing assets stems from forgetting about depreciation.

Wear and tear take a toll on everything, such as buildings, equipment, vehicles, computers, etc. When figuring assets, a depreciation factor must be built into the effort. The commitment to accuracy means that receivables long past due must also be depreciated; with each passing day, it’s less likely a long unpaid bill will be paid.

Time goes so quickly it’s easy to forget to regularly evaluate depreciation. One item that helps a business stay on track with the effort is insurance. When insurance policies are renewed, usually annually, the insurer will want an updated list of assets and their value.

Where is the money? That’s what a budget tells an owner (money including assets).

The balance sheet and P&L statement give a quantitative representation of the “where” from different angles. The balance sheet shows the financial condition at a particular time, i.e. on the day it is completed. It stands as a snapshot on the date attached to it.

Well-designed balance sheets give an owner a good idea of how different segments of a business contribute to the bottom line. Separate online and in-person sales so they can be compared. Furthermore, separate each category by the amount of sale to make more refined comparisons easier.

A balance sheet feeds into a P&L statement. The P&L statement shows the difference in the business/operations between two dates. Week-to-week, month-to-month or year-to-year, the P&L indicates the financial direction of the company—up, down, or stable.

Cost-benefit analysis (CBA) of business activities can be done using balance sheets. Should a new service be offered by a contractor? Determine the cost of equipment and chemicals and a new hire, if needed. What about the cost of another license or more insurance? The service can only be added if the benefits (new sales) outweigh the costs of obtaining the sales.

A budget keeps an owner realistic. When every expenditure is tallied, the cost of doing business cannot be underestimated.

In 2023, there are as many ways to underestimate expenditures as there are layers of expense. Business budgets must include reserves for the unexpected.

Unexpected and nonnegotiable items, such as fuel charges suddenly added by a freight carrier or changes in bank fees, can’t be known in advance. Surprises come from every direction, including theft.

With local governments increasingly refusing to prosecute crimes that involve sums under $1,000 to $2,000, businesses have lost a significant deterrent. That adds another expense to the budget: more anti-theft protection (e.g., lighting, alarms).

The severe countervailing forces on businesses in 2023 cannot be overcome with a good understanding of budgets alone. But should an unanticipated event occur—from a natural disaster to a fine or a crime—an owner who has a thorough understanding of the company’s budget can respond with prudence.

A fine? Yes, a special report in the June 2023 publication Business Insurance notes that since 2021, OSHA inspections have increased by 20 percent, and fines for citations have increased (six figures is the new four figures).

With costs and crime on the rise and a federal “budget” in disarray, what is a business to do? Understand and keep a good budget and become a model to others.