Five Critical Reasons to Have a Budget

Updated: May 12, 2019

As an organizational leader or business owner, you've probably heard a lot of talk about finances and budgets and blah blah blah. You've been managing for awhile without a budget and things have gone alright, right?

Maybe. The answer to that is maybe. Maybe things are going alright, but maybe they aren't. Can you really say for sure? Do you have the numbers to back that up?

That's a main reason why having budgets is so important. They can be an excellent tool for getting a pulse on your organization's financial situation.

But let's not get ahead of ourselves.

Before we get into that, let's first answer the basic question: What is a budget anyway?

In general, a budget is a listing of all of your expected revenues and expenses over a give period of time. For example, if you, personally, make $4,000 per month in wages and pay $1,000 per month in rent, you know you should budget about $48,000 in revenue and $12,000 in expenses for the year. So your net income is budgeted at $36,000. Not too shabby.

And wouldn't it be great if it were that simple? But of course you have to eat, so you budget for food costs. And you have to include cell phone service, and you're also out of shampoo, so you add those to your budget. And then you remember that your grandmother still gives you $25 every year for your birthday. Should you add that to your budget, too?

It starts to get complicated very quickly, and that's just for your own personal finances. Imagine how much more complicated it can get when you're building a budget for an organization.

This isn't meant to scare you. A budget can be very complex, but it doesn't always have to be. Maybe instead of building a budget for an entire organization, you just need to have a budget for a small dinner you're throwing for your biggest supporters. Or perhaps you need an annual budget for your marketing department only.

A budget can be as big or as small as you need it to be to start. If you decide to start small, you can -- there are no rules here! BUT we do recommend that you set a goal to eventually build your budgets at an org-wide level, because it can help you immensely.

Why should you build a budget? We've laid out this handy article to give you 5 simple reasons:

1. Budgets let you clearly see what's happening.

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Where does most of your revenue come from? And what do you spend the most on?

You can make some educated guesses, but building a budget can help you answer both of these questions with more certainty. For one, the first step of creating a budget involves looking at what happened last year (and the year(s) before that). Your accounting system can give you some historical reports, and when you're actually building the budget yourself, you become much more familiar with what each of those lines entail.

It's especially helpful to separate your organizational budget into small budgets, such as profit centers, programs, departments, or specific events. This will give you a much clearer indication of which of your activities are making money and which are losing money. Once it's all laid out in front of you, you'll start seeing patterns emerge, which leads us to reason #2:

2. Budgets help you make decisions.

Photo by Kyle Glenn

In addition to seeing patterns, budgets help you critically analyze the decisions you've made so far which will allow you to make better decisions in the future. For example, are there areas you've been inadvertently prioritizing?

As you scrutinize your expenses, you may find yourself saying, "Why have we been spending so much money on office supplies?" or "I didn't realize 25% of our budget was going to Advertising and Marketing." Creating a budget allows you to make needed adjustments for the coming year (and also maybe get a better handle of your internal policies and practices).

On the revenue side, you may notice your holiday card sales have done surprisingly well, and maybe it's time to think about putting more resources toward that program and ramping it up a bit. Or maybe an area of revenue you thought was the most significant to your organization really doesn't bring in that much more money than other areas. This can make you rethink your entire strategy.

Budgets also give you a heads up in terms of where you have some flexibility. You want to be sure you have some backup plans in place in case, for example, your first quarter revenue is slightly lower than you planned. You know you've budgeted an extra $1,000 in software upgrades that can wait until next year, which will help you make up for that unexpected dip in sales or donations.

3. Budgets help you measure your performance.

Photo by Carlos Muza

After you have a budget in place, you'll want to check in throughout the year to see how you're measuring up. After all, what sense does it make to create a budget that you never look at again?

Most accounting programs have a Budget-to-Actuals report (sometimes called a Budget Variance report) built in as a standard. This report allows you to go in and check -- at any time -- how your organization is actually doing compared with how you thought it'd be doing.

We recommend reviewing the report at least four times per year, at the end of each quarter, for example; although, you may want to consider reviewing it at the end of each month to keep a closer eye on things. This will help you not only see large (and perhaps unexpected) variations from your initial expectations, but it will also help you catch errors that might have been made. ("Did we really spend $500 last month on parking?? ...Or maybe something was miscoded.") Either way, significant deviations should be very clear and obvious in the report.

And remember, revising your budget is ok! Let's say you originally budgeted $75 per month for internet fees, but then you receive a notice saying your bill has increased to $80 per month (not terribly far-fetched with most providers)?

You can -- and should -- adjust your budget as you learn new information. For example, to make up for that unexpected increase in internet fees, you might decide to decrease your budget somewhere else. That's a perfectly ok think to do!

(Some advice: It might be good to make an additional copy of the budget as you make revisions. We've always found it to be incredibly useful to have a record of the original, unchanged budget as a reference. And if your organization is required to get budgets approved, such as with nonprofits, it'll be even more important to keep the original.)

4. Budgets help you prepare for a worst-case scenario.

Photo by Fabian Blank

Your budget will never be perfect. Your revenues and expenses will rarely end up being exactly what you thought. Things will always come up, and situations will always be unexpected. Because that's life.

What you can do is have contingency plans in place. As you build your budget, add some cushion in there -- think about what could happen and adjust a bit to account for it. Some organizations even elect to add an expense line named "Contingency," and they'll dump an extra few thousand dollars in there. It's similar to a rainy day fund where you're planning for the just-in-case.

Hopefully, you never have to touch that line. But if the cost of your workers' comp insurance suddenly skyrockets, or if some viral video causes a negative PR backlash and your revenues plummet, having some padding in your budget can help keep you afloat.

5. Budgets help you plan for the future.

Photo by Patrick Perkins

Having a budget in place will be critical as you think about your organization's growth, strategy, and long-term planning. It gives you a starting point against which to set your goals and targets and can help you measure how you're doing in reaching those goals.

Maybe you're thinking about upgrading your equipment. Maybe it's about time to expand your organization and add another location. Or perhaps you plan on having a big campaign to celebrate your organization's ten year anniversary. No matter what your short- and long-term plans are, a budget can help you remember to set aside funds for specific purchases like these and others that may not occur year to year.

Finally, budgets allow you to manage proactively, giving you the tools to be in more control of your revenues and expenses and avoid having to figure out how to respond to issues on the fly. And ahhh, that would be nice.

Organizational, departmental, and event-specific budgets are an incredibly useful tool that we encourage you to utilize. They allow you to make better decisions, be proactive in your financial management, and prepare and plan for the future. And although they seem big and scary at first, once you get in there, you'll realize they're not so bad. And you might even enjoy the control and flexibility they give you in managing your business, making your life just a little bit easier. And who doesn't want that?

Once you've made having a budget a critical part of your organization, then you can better answer the question implied at the beginning of this article: How are things going in your organization?

#Accounting #BestPractices #Budget #Expenses #Growth #Management #Nonprofit #Planning #Revenue #SocialEnterprise

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