Budgets Are Key For Planning and Analysis
Would you be surprised to learn that more than half of small businesses create a budget? Budgeting isn’t reserved for struggling startups or large organizations that have millions of dollars to allocate. In fact, all businesses can benefit from budget creation, especially on a quarterly basis.
In this article, we’ll explore the basics of quarterly budgeting, including the benefits, the risks associated with bypassing a budget, the steps in the budget preparation process, and how to conduct variance analysis.
What is a Quarterly Budget?
Quarterly budgets track the financial health and profitability of your organization every three months. If your business isn’t struggling with cash flow or working diligently toward a specific profitability goal, you might not need to budget on a monthly basis; however, you shouldn’t neglect quarterly budgets.
A quarterly budget will compile historical information, such as from the prior three-month period, project where your business should be heading, and the steps needed to get there. For example, if you are trying to improve the valuation of your business, you might look to increase sales. How will you do this? By allocating more resources to your advertising budget? How about hiring an additional sales employee?
Quarterly budgets help you review past historical data and outline actionable strategies to reach your financial and operational goals. Most quarterly budgets focus on the income statement, but some analyze your entire financial picture, including the balance sheet and cash flow statement.
The Benefits of Quarterly Budgeting
The performance of your organization can drastically change over a three-month period. You might have reached a newfound customer base that increases your sales or have an underperforming segment from an uptick in competition. Regardless of which situation your business is in, it’s important that you properly plan for resource allocation.
Improper resource allocation can lead to overspending and lower profitability.
The contrary is true as well. You might be underspending in value-added categories. What if shifting $10,000 in office expenses to advertising allows you to double your target market reach? Or what might happen if 2% of sales were reinvested into the company for added growth? These are all opportunities that the quarterly budgeting process helps you take advantage of.
Furthermore, quarterly budgeting is indispensable if you are trying to improve operating cash flow and drive a higher valuation. When prospective buyers inquire about cash flow, profitability, and expected sales, can you answer their questions confidently? The budgeting process sheds insight into your operations, allowing you to be prepared for whatever questions are thrown your way. Check out our post here for additional information on preparing for a sale.
The Risks of Foregoing a Quarterly Budget
The risks of foregoing a quarterly budget can be severe. For one, your organization might suffer from stagnant growth. Budgeting aligns your financial goals with operations. Without the quarterly budgeting process, you might have a poor understanding of where your financials end in the quarter and no insights into how to improve.
Moreover, neglecting a quarterly budget can result in minimal transparency into the downside scenario. The downside scenario can reflect numerous business challenges, such as declines in growth, a recessionary environment, or inflationary pressure on operating expenses. Without fully evaluating the impact of certain scenarios on the financial health of your organization, you may incur increased levels of business and financial risk.
How to Forecast Quarterly Revenue and Expenses
Now that we’ve outlined the importance of quarterly budgets, let’s discuss how quarterly revenue and expense forecasts are constructed. This process isn’t a one-size-fits-all approach. In fact, you will need to customize the process to fit your business goals and objectives. Nevertheless, here’s a basic outline of how to piece together your quarterly budget.
Review Historical Information – The first step in creating your quarterly budget is to review historical information. Pull financial statements for the prior 12 months and analyze your results. Is your business cyclical? Cyclicality occurs for a variety of reasons, from seasonal business to changing customer demands. Is revenue trending higher? Are margins flat, expanding, or contracting? How do you expect these trends to affect business performance moving forward?
Determine Goals – Next, you need to pinpoint your financial and operational goals for the upcoming quarter. Do you strive to increase revenue by a certain percentage? If so, what assumptions can be made about product price and quantity? Or maybe you desire to improve profit margins by analyzing operating expenses to determine which uses of cash may be low-yielding, or unnecessary.
Create a Roadmap – Now that you understand your historical information and your goals for the next quarter, you will forecast quarterly revenue and expenses. Be realistic. If your historical information supports a 1% growth rate each quarter, don’t forecast a 5% growth. The same goes for expenses. If you are aware of events that would accelerate, or decelerate, growth or expenses from the historical trend, note these assumptions in your budget notes.
Evaluate Progress – Although it can be beneficial to review your quarterly budget progress on a monthly basis to make adjustments, you should at least review actual results after the quarter closes. We’ll dive into how to conduct variance analysis below.
This is the basic process that your team should go through every quarter.
Conducting Variance Analysis
Your actual financial results won’t always align with your budgeted amounts. That’s ok. Predicting the future is hard, especially for high growth businesses. But it’s important that you understand what caused the variances in your actual results relative to your budget. This way, you’ll keep a pulse on the performance of key budget line items, while positioning yourself to produce future quarterly budgets that show lower variance as your budgeting process becomes more accurate.
Variance analysis can either be done through monetary figures or percentages. To start, you will need to determine your acceptable variance range. Is it 5% of the budgeted amount or a flat dollar amount? Once you’ve identified your variance threshold, you will calculate variances by comparing the actual revenue and expense figures to your budgeted revenue and expense figures. As you notice sizable variances, slow down, dig into the category and make sure you’re aware of the reason for the variance.
Next Steps
Preparing quarterly budgets is an integral component of running a successful organization, regardless of your goals. However, preparing and reviewing a quarterly budget for the first time can be daunting. Review historical performance, assess trends in the business, and make your best estimate of how a quarter may unfold based on your knowledge of the business. After you complete a few quarterly budgeting exercises you’ll be surprised at how adept you can become at planning for your business’s performance.
