Budgeting Methods: 3 Ways that Work Best for Small Businesses

As a small business owner, finding the right budgeting method is crucial for financial success. In this blog post, we will be discussing three budgeting methods that have proven effective for small businesses. But first, you need to know why your business needs budgeting. 

The power of budgeting in business

budgeting methods in small business 1

John and Jane were the proud owners of a small coffee shop. They had always struggled to make ends meet, despite the steady stream of customers coming through their doors. They needed to find a way to manage their finances better to keep their business afloat.

That’s when they turned to budget. With the help of a financial advisor, John and Jane were able to create a budget that took into account all of their income and expenses. They were surprised to discover that they had been overspending on things like inventory and employee wages.

By making some adjustments to their budget, John and Jane were able to reduce their costs and increase their profits. They were able to pay off debt, save for the future, and even expand their business. Budgeting may have been a daunting task at first, but it ultimately helped John and Jane get their finances under control and keep their coffee shop thriving.

Maximize financial success through budgeting

Budgeting is essential to successful personal and business finance management. It allows people to identify, manage, and prioritize their financial goals, ensuring their assets are allocated appropriately for the desired outcomes. Having a clear budget helps keep spending in check, minimizes debt accumulation, improves savings potential, facilitates intelligent investment decisions, and generally establishes a pathway toward responsible debt management.

Book: Better Your Business Budgeting: The Untold Secrets To Making Your Business Budgeting A Success Rather Than A Nightmare

By identifying potential areas of surplus or coming up with strategies to increase cash flow, budgeting encourages proactive steps toward financial health. Businesses that track expenses through detailed budgets may also benefit from tax savings; creating fiscal orders can lead to a lower liability when filing taxes. Ultimately, both individuals and organizations should incorporate budgeting into their long-term financial strategy in order to ensure effective decision-making and build a foundation of economic prosperity.

Common steps in budgeting methods for business

budgeting methods in business common steps

Budgeting is an important aspect of financial management for small businesses. It involves creating a plan for how you will allocate your financial resources over a specific period of time, usually a year. A budget helps you manage your cash flow, track expenses, and make informed decisions about how to allocate your resources. Every business must adhere to certain budgeting procedures no matter which budgeting method they follow.

  1. Determine your business’s financial goals: What do you want to achieve financially in the next year? Your goal could be to increase sales, control expenses, or both.
  2. Identify your sources of income: Make a list of all the sources of income for your business, including sales, investments, and loans.
  3. Estimate your expenses: Make a list of all the expenses your business will incur in the next year, including fixed expenses (such as rent and salaries) and variable expenses (such as supplies and marketing).
  4. Create a budget: Use your income and expense estimates to create a budget for the year. Make sure to analyze the suitability of budgeting methods and allocate your resources wisely and leave room for unexpected expenses.
  5. Monitor your budget: Keep track of your actual income and expenses and compare them to your budget. Revisit significant deviations and introduce controlling mechanisms to stay on track.

Article: 8 Reasons to Hire a Professional Accountant for Your Business

By following the above steps and creating a budget, you can improve your financial management and increase the chances of success for your small business.

3 budgeting methods for small businesses

For every business, regardless of size, budgeting is a process that requires meticulous attention to detail. It involves accurately assessing activities, setting and revisiting targets, and coordinating between different functions. No matter the process adopted, there are three budgeting methods that can be applied to any budget-making process:

Activity-based method

Activity-based budgeting (ABB) is a powerful method of budgeting that focuses on the activities that drive costs in an organization. Unlike traditional budgeting methods, which often start with a budget based on past expenditures and then allocate funds to different departments or projects, ABB begins with an in-depth analysis of the activities that drive costs within the organization. This analysis is used to create a budget that accurately reflects the true costs of each activity.

For example, consider a manufacturing company that produces a variety of products. The traditional budgeting method might allocate a fixed amount of money to the production department based on past spending patterns. However, with an ABB approach, the company would first identify all the activities that drive costs within the production department, such as machine maintenance, raw material purchases, and labor costs. The company would then allocate funds to each of these activities based on the expected level of expenditure. This allows the company to more accurately predict and control costs, as it is able to budget for the specific activities that drive expenses rather than relying on broad estimates.

Article: How to Manage Your Business Costs?

ABB is a budgeting method that can be incredibly useful in situations where an organization has a complex business model or operates in a rapidly changing environment, as it allows the company to be more agile and responsive to changes in demand or costs. It can also help organizations that want to learn more about what causes their costs since the ABB process requires a detailed analysis of the things that cause costs.

Zero-based budgeting

Zero-based budgeting (ZBB) is a powerful tool for businesses to ensure that every expense is justified and that resources are allocated in the most efficient and effective manner. Zero-based budgeting doesn’t use the budget and spending from the previous year. Instead, it starts with a clean slate and asks for each expense to be justified for the next period.

For example, a company with a budget of $100,000 for the coming year would typically start by looking at its expenses from the previous year and making adjustments accordingly. However, with zero-based budgeting, the company would start by considering all of its expenses from scratch and justifying each one based on its expected value in the coming year. This could lead to the same expenses being put in the budget, or it could lead to a very different budget if some expenses are not justified or if new expenses are found.

Article: Why Management Accountants are Important for Business?

The primary benefit of the zero-based budgeting method is that it can help a company be more efficient and effective by forcing managers to justify every expense. However, it can also be time-consuming and may not be suitable for all companies.

Incremental approach

The incremental approach to budgeting is a method of creating a budget that builds upon the previous year’s budget, making adjustments based on expected changes in the coming year. This method takes into account the changes that have happened in the business over the past year and includes them in the budget for the coming year.

For instance, let’s say a company has a budget of $100,000 for the current year. During the year, the company experiences an increase in demand for its products and services, resulting in an increase in revenue. As a result, the company decides to increase its budget for the coming year by 10%, or $10,000, to reflect the increased demand. The company’s budget for the coming year would therefore be $110,000.

The incremental budgeting method is often utilized due to its simplicity and ease of understanding. It also allows companies to make gradual changes to their budget over time, which is especially beneficial for companies that have consistent operations and do not experience drastic changes from year to year.

Key differences between ABB and ZBB budgeting methods

The various budgeting methods differ in approach and processes. Some key differences between zero-based budgeting and activity-based budgeting include:

  • Zero-based budgeting focuses on the allocation of resources, while activity-based budgeting focuses on the activities that drive costs.
  • Zero-based budgeting starts from “zero base” and requires all expenses to be justified. Activity-based budgeting, on the other hand, uses a baseline budget and only needs changes from the baseline to be justified.
  • Zero-based budgeting is typically more time-consuming and resource-intensive, as it requires a thorough review of all expenses for each budget period. Activity-based budgeting may be less time-consuming, as it only requires a review of the activities that drive costs.
  • Zero-based budgeting may be more effective at identifying and eliminating unnecessary expenses, as all expenses must be justified. Activity-based budgeting might be a better way to figure out and lower the cost of certain activities.

The importance of budgeting and its limitations

Budgeting is a key tool for management in organizations, as it helps to effectively allocate resources and achieve overall goals. It involves creating a plan for investments and expenses and can bring transparency to decision-making processes by encouraging debate and bringing interdependencies to light. The budgeting process can also facilitate coordination between different areas and departments, as well as allow for early decision-making and promote a sense of commitment and responsibility among those involved.

Article: Accounting Software and Training – Crucial Things to Know

However, budgeting is not without limitations. It can be time-consuming to create and maintain a budget, and it requires accurate forecasting and estimation, which can be difficult in uncertain or rapidly changing environments. Additionally, the focus on budget targets can sometimes lead to a narrow, short-term focus rather than a long-term strategic vision. Overall, budgeting can be a powerful tool for management, but it is important for organizations to carefully consider its benefits and limitations and to use it in a way that aligns with their overall goals and objectives.

Conclusion

By now, you should have realized the importance of budgeting for your business. It is essential for ensuring control and accountability and can help your business thrive this year. To create a successful budget plan, you need to have a deep understanding of your business requirements and update them regularly to avoid any potential issues in the future. Budgeting constraints are also important to consider in any budgeting method you follow. 

As an entrepreneur, you are the captain of your business. To ensure success and financial security in the long run, you need to be well-prepared. I offer reliable budgeting services that can help you create a solid financial plan for your business. If you need my assistance, please contact me.

One Response

Add a Comment

You must be logged in to post a comment