It is good practice to annually evaluate your performance throughout the year. After all, identifying your strengths and opportunities are essential to growing the company. A key part of these business planning sessions involve setting next year’s annual budget, and this article will help you bring structure as you do so.
Why Set an Annual Budget for Your Business?
It is really necessary? The answer is definitely yes.
As businesses continuously win sales, it is easy to get oblivious to the flow of expenses.
Deciding on an annual budget prior to the start of the year helps keep disbursements in check. It also encourages efficiency in spending—getting only what is necessary to run and grow the business. This is important for cost centers like Marketing Teams, where Return on Investment (ROI) is difficult to show.
Following a budget is important for capital expenditures.
Companies who are saving for costly machinery or property need to correctly allocate their finances. Through clever spending, they can purchase their investments without needing external funding! Should it be necessary to get a loan, lenders will appreciate knowing that the company is taking specific steps to pay it back.
An annual budget is a good indicator of management’s priorities.
Huge allotments to Product and Research Teams show the business’ commitment to innovation. Meanwhile, a heavy focus on HR Teams displays their attention to employees. Your budget shows the path that you’re taking to make sure that your company’s vision comes to life. Internally, showing your team that you put money where your mouth effectively drives up engagement.
5 Steps to Follow in Setting Your Business’ Annual Budget
Step 1: Start Early
Good for you if you’re reading this before the -ber months even began! Especially if it is your first time to set an annual budget for your business, starting early is key to proper planning. This leaves room for further research and even errors and revisions. Preparing in advance also gives your team time to make their own plans according to the budget that you’ll set.
In a similar manner, most businesses become extremely busy as the year comes to a close. HR Teams organize year-end events, while Finance Teams get ready to close the books. For the Sales Teams, it’s crunch time as they work towards reaching their annual quotas. The end of the year is a hectic time for everyone, so you’ll do well scheduling your budget planning sessions before all the buzz.
Step 2: Prepare Your Financial Records
Once you’ve scheduled planning meetings with your key employees, it’s time to get down to business. With the help of your managers, draw up the following information:
1. Projected Sales
Predict next year’s revenue by identifying the growth rate of your historical sales numbers. This will be your guide throughout the whole budget planning process.
Then, do a check-up of your profit margins. This article will help you identify if yours are too low or too high. Upon evaluation, apply your changes to your forecast.
2. Projected Expenses
When there is income, expect expenses too. Using the projected amount of sales, use your Gross Margin Ratio to calculate your Cost of Goods Sold (COGS).
It is computed by dividing your Gross Profit by Net Sales.
Gross Profit Margin Ratio = ((Net Sales – Cost of Goods Sold) / Net Sales) x 100
Similar to the process of forecasting sales, project your other expenses using historical data. Combining the two amounts will get you your projected expenses for the next year.
3. Employee Forecasts
After identifying your sales and expenses estimates, create one for your employee base. Salaries and wages are one of the highest expenses for businesses, so it is important to account for them when planning. Additionally, your employees are key to achieving your forecasted sales numbers. Make sure to plan your teams’ growth parallel to your predictions.
4. Planned Investments
As mentioned above, huge capital expenditures can cause a major dent in your business’ finances. Properly plan for these investments by doing extensive research. Before making sure that you’re getting the best value for your money, evaluate if this is really the best choice for the business.
On the other hand, check your options. Looking into software with a hefty one-time fee? Get one on a subscription basis instead! Cloud-based platforms like MPM Payroll offer tiered payments, so you only pay for the features you need.
Step 3: Communicate With Your Employees
One way or another, your employees will know about the results of your budget planning sessions. You can approach this in two ways:
Top-Down Approach
This method refers to communicating your business’ budget and plans for the next year after the sessions are done. It means that the decision came from top management and each team will adjust their planned expenses based on the set financial plan.
Bottom-Up Approach
The other way involves communicating with your team right from the start. This process signals trust and allows ideas to stem from your employees.
Each of the two has its pros and cons. The Top-Down Approach ignores ideas that can stem from employees who deal with the business’ daily operations. Meanwhile, the Bottom-Up Approach can lead to a lack of strategic vision that management usually provides.
We suggest doing a mix of both! Prior to management meetings, each team should propose their budget plans for the following year. Then, during the planning sessions, you can approve, reject, or adjust these proposals based on strategic goals. In the end, management’s final decisions will be relayed to all employees as they adapt their plans based on approved budgets.
Step 4: Keep Seasonality In Mind
Your annual budget will be further subdivided into 12 months for next year. If your business experiences seasonal fluctuations in sales, make sure that this is reflected in your budget plans.
Two possible strategies are to:
- Allow for minimal expenses during lean months and bigger allocations on peak months; or
- Spend more during lean months to focus on boosting sales and lessen costs on peak months since it’s easier to sell.
Let’s look into schools as an example. They get the bulk of their income during the academic year, usually divided into two semesters. During that time, it wouldn’t make much sense to do heavy marketing because most students have already enrolled and paid for their tuition. Instead, they can focus on marketing during the off-peak season. They can aim to attract incoming freshmen or encourage transferees.
In the end, your strategy depends on your type of seasonality.
Step 5: Account For Unexpected Circumstances
The pandemic has adversely affected several businesses all over the world. This simply goes to show that markets are volatile and emergency funds are necessary.
No one expected this pandemic, let alone that it can cripple even the biggest companies. As such, companies who employ proper financial planning are those who endure.
Follow these 5 steps and properly plan for your financials for next year. Although, remember that planning is simply an initial part of the process. You need to follow through your plans and be able to adjust when necessary.
