Budgeting

Budgeting means drawing up a statement showing all planned revenue and costs for a given period. A budget acts as a financial road map for how the company plans to use its financial resources.

Three types of budget are mainly used:

1. Operating budget (profit and loss budget)
2. Investment budget
3. Cash budget (liquidity budget)

The operating budget

The operating budget is a complete overview of a company's expected revenue and costs in a given period. It shows three possible outcomes:

• The company breaks even: Revenue minus costs = 0
• Loss: Revenue minus costs < 0
• Profit: Revenue minus costs > 0

The investment budget

The investment budget gives an overview of how the costs of planned investments in a given period are to be spread, together with an overview of how those costs are expected to be financed.

The cash budget

The cash budget also gives an overview of planned revenue and costs, in the same way as the operating budget, but the focus is on the ability to pay, that is on liquidity. It gives an overview of the expected cash flow and assesses whether measures are needed to improve liquidity.

How do you draw up a budget?

A budget is set up in accordance with a given financial strategy. It is advisable to analyse the current finances and earlier periods as a framework for the new budget. Financial forecasts for the coming periods should be considered as part of the strategy.

The practical design varies according to the company's areas of focus. If a company sells a lot of product A, it may be advantageous to allocate more resources there. Higher expected earnings can make it possible to increase the total budget instead of cutting costs on other items.

What can budgeting be used for?

Budgeting is important for financial management. It is used to:

• Draw up an action plan for the allocation of resources.
• Optimise spending.
• Show the financial strategy for achieving the targets.
• Measure financial performance.

Budgeting is also important for measuring performance. Financial performance can be assessed by looking at how well the company has stayed within the budget.

Use of the investment budget: The investment budget plans future investments and monitors the profitability of existing ones. A high investment budget indicates plans for new initiatives or product launches. A low budget suggests limited focus on new investments.

Use of the operating budget: The operating budget is used as the basis and framework for the financial strategy and the action plan. A high budget indicates expected high earnings with low costs. A low budget suggests expected low earnings with high costs.

Use of the cash budget: The cash budget is used to evaluate and keep control of the company's liquidity in any given period. A high budget indicates a strong ability to pay, a low one suggests a weak ability to pay.

10 tips for optimal budgeting

It can be difficult to estimate expected expenses and revenue in a given period with the greatest possible accuracy, but there are various measures that can make budgeting both easier and better.

1. External help: Consider whether there is a need for digital solutions or consultancy services to help.
2. Strategy: Decide the overall company strategy for the coming period before budgeting.
3. Historical evaluation: Carry out a thorough evaluation of the previous period's budget and finances.
4. Detailed forecasts: Use the results from point 3 to draw up detailed financial forecasts for the coming period.
5. Estimate of revenue and costs: Use the results from point 4 to decide an estimate for the costs and revenue in the coming period.
6. Investments: Consider whether new investments should be made.
7. Investment budget: Set up the investment budget first, to give a financial representation of the strategy.
8. Cash budget: Set up the cash budget to give an overall framework for costs and revenue.
9. Size of budget items: Carry out a numerical weighting to determine the size of the budget items on the basis of the financial strategy.
10. Operating budget: Use point 9 to set up the operating budget.

Advantages and disadvantages

Operating budget

Advantage: The operating budget gives a good overview of all the costs a company expects.

Disadvantage: Greater risk, since the combined margin of error across all the cost items can become large if several items are inaccurate.

Investment budget

Advantage: Gives an overview of planned investments and projects.

Disadvantage: It can be difficult to estimate the costs of a new investment. The company probably has limited knowledge of how the market will react and of the costs that will follow.

Cash budget

Advantage: The cash budget gives a good overview of the company's planned cash flow.

Disadvantages: It does not focus on growth or profitability. Financial forecasts are only estimates, and payments of income may be delayed.

The combined perspective

It is an advantage to look at the different budgets together rather than in isolation, in order to get a detailed overview of all costs, investments and expected liquidity.

One general disadvantage is that budgeting work takes time and resources. In addition, changes in the market can quickly make the budgets out of date.

Read more about how Capassa can set up your budget automatically.