When people hear the word “Budget”, they often think of strict restrictions on spending. Having to track every penny and saying, “Oh, I can’t go to the movies with you, it would blow my budget.” But like the dieter who morosely counts every calorie and dreams of forbidden ice cream, this type of budgeter is doomed to failure.
A better name for a Budget is a Financial Plan. Why is that?
A financial plan is a road map, a sketch, a planning tool for your activities over a period of time, usually a year. It describes not only the activities which spend money, but also the activities that will *generate* money.
Your financial plan covers both the income and outflow. Why is this distinction important?
Drafting a financial plan begins with the activities you do to generate income.
For example, if you are a business or an earned-income based nonprofit, how many “widgets” do you think you will sell next year? How many customers will buy your product? And what will it cost you to sell & produce these widgets, plus cover your overhead and growth needs?
If your nonprofit is mostly grants-based, you need to carefully analyze your chances of fundng for the next year and how you will bring in enough to cover your activities. You also need to consider if the income next year is less than this year, what actions will you take? Have one less teen counselor and help 30 less kids? Try a new type of fundraising event?
The next step is to compute the cost for this planned level of activity. How many staff hours will it take? How much does it cost to make a widget? You also need to remember to cover overhead and future growth needs.
Overhead is the day to day expenses you have regardless of how business is doing – rent, internet, and administration salaries like the CEO, finance department and HR.
Future growth needs are costs to help you build your business – staff training, product research and development, and putting aside money to replace your current machinery and technology every few years (depreciation).
Budgets are never easy to balance when designing them, and the plan for your income and expenses never works out exactly as you imagined it. It is an on-going, important management process.
Example – Small business web designers
Two friends join together and create a partnership to provide web design and on-going tech support. New customers pay $2,000 – $5,000 for a complete new website, then pay $200 – $500 annual for on-going tech support and updates. Last year they had 28 new customers. This year they hope to have 40.
But what are their expenses to get these 40 new customers and support the 28 on-going ones? Advertising? Server space? Staff time & salary? And what about depreciation on their snazzy computers they bought last year? (Each year they need to save some money to replace their computers after three or four years.) Do all the expenses total more than the planned income? Maybe they need to raise their prices, or find even more customers.
The budget planning process is a management tool. Working through the budget based on planned activity levels helps you work out in advance if your planned income will support the expected related expense. And your income should also cover any additional expenses to support future growth needs, such as staff training or additional advertising.