There are few skills as critical to running a business as budgeting. Yet, over half of the executives surveyed in a 2019 McKinsey study report feeling dissatisfied with the transparency surrounding their organizations’ budgets.
Any employee—especially managers—should understand budgeting and how it can profoundly impact an organization.
Here’s a primer on the importance of budgeting in business.
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Budgeting is the process of preparing and overseeing a financial document that estimates income and expenses for a period. For business owners, executives, and managers, budgeting is a key skill for ensuring organizations and teams have the resources to execute initiatives and reach goals.
A basic budget consists of projected income and expenses for a given period (for instance, the upcoming quarter or year). After expenses are subtracted from projected income, the leftover money can be allocated to projects and initiatives, ensuring you’re not planning to overspend.
Budgets from previous periods can be compared to the company’s actual financial allocation and performance, giving an idea of how close predictions were to actual spend.
For example, imagine you allocated $10 million for your company’s annual corporate social responsibility (CSR) project. Unforeseen circ*mstances caused it to run $1 million over budget, and that money had to come out of other projects’ budgets.
During the project’s postmortem, you ask questions like, “Why did we run over budget? Was this an issue of inefficiency or misallocation?” When creating the budget for next year, you use those insights to tighten the process and keep the project’s spend at $10 million or more accurately allocate funds to other projects.
Types of Budgeting
There are several budgeting types that each prioritize different factors when approaching a financial plan. These include:
- Zero-based budgeting, which sets each item at zero dollars at the start of periods before reallocating
- Static budgeting or incremental-based budgeting, which uses historical data to add or subtract a percentage from the previous period to create the upcoming period’s budget
- Performance-based budgeting, which emphasizes the cash flow per unit of product or service
- Activity-based budgeting, which starts with the company’s goals and works backward to determine the cost of attaining them
- Value proposition budgeting, which assumes no line item should be included in the budget unless it directly provides value to the organization
The right budgeting type varies by company and situation. If your organization is in financial distress, the zero-based method may be the best fit, as it starts from scratch each period. Trying out several methods is a good way to determine which is ideal; when doing so, ensure your entire organization is aligned.
Related: 6 Budgeting Tips for Managers
Why Is Budgeting Important?
Budgeting involves number-crunching, attention to detail, and making informed decisions about fund allocation—but it’s well worth the effort. Here are five reasons budgeting is important in business.
1. It Ensures Resource Availability
At its core, budgeting’s primary function is to ensure an organization has enough resources to meet its goals. By planning financials in advance, you can determine which teams and initiatives require more resources and areas where you can cut back.
If, for instance, your team needs to hire an additional employee to scale efforts, budgeting for that in advance can allow you to plan other spending.
2. It Can Help Set and Report on Internal Goals
Budgeting for an upcoming period isn’t just about allocating spend; it’s also about determining how much revenue is needed to reach company goals.
You can use budgeting to set company-wide and team financial goals that align with them. This is especially prominent when using activity-based budgeting, but it’s beneficial no matter which type you use.
Financial goals should be attainable enough that you count on them to inform the rest of your budget allocations. Your goals inform the expenses needed to reach them and vice versa.
You can also use budgeting to update employees on progress and revisit the next period’s goals. For instance, if your company aimed to gain 10,000 new users this past year but fell short by 4,000, what could you have done differently? Does the initiative require fund redistribution? What resources could have propelled progress?
Tracking progress, or lack thereof, allows you to align your team and plan for growth in the next period.
3. It Helps Prioritize Projects
A byproduct of the budgeting process is that it requires prioritizing projects and initiatives. When prioritizing, consider the potential return on investment for each project, how each aligns with your company’s values, and the extent they could impact broader financial goals.
The value proposition budgeting method forces you to determine and explain each line item's value to your organization, which can be useful for prioritizing tasks and larger initiatives.
4. It Can Lead to Financing Opportunities
If you work at a startup or are considering seeking outside investors, it’s important to have documented budgetary information. When deciding whether to fund a company, investors highly value its current, past, and predicted financial performance.
Providing documents for previous periods with budgeted and actual spend can show your ability to handle a company’s finances, allocate funds, and pivot when appropriate. Some investors may ask for your current budget to see your predicted performance and priorities based on it.
5. It Provides a Pivotable Plan
A budget is a financial roadmap for the upcoming period; if all goes according to plan, it shows how much should be earned and spent on specific items.
Yet, the business world is anything but predictable. Circ*mstances outside your control can impact your revenue or cause priorities to change at a moment’s notice.
Consider the onset of the coronavirus (COVID-19) pandemic in 2020. The economic impact of travel bans, lockdowns, and other safety precautions was far-reaching and unexpected. Executives were forced to quickly—yet thoughtfully—rework budgets to account for major losses and newfound safety concerns.
More than two years later, executives are rethinking their budgeting procedures to make it easier to pivot if needed. One shift noted by McKinsey is the turn toward zero-based budgeting to determine the minimum resources necessary to survive as a business—should the circ*mstances call for it.
A budget gives you a plan; maintaining an agile mindset enables you to pivot that plan and help lead your organization through turbulent times.
Learn to Budget Effectively
Anyone can learn to budget effectively and reap the benefits. To build a foundation of financial literacy, gain a deeper understanding of the levers that impact an organization’s finances, and discover how budgeting can enable you to become a better leader and manager, consider taking an online financial accounting course.
Do you want to take your career to the next level? Explore Financial Accounting—one of three online courses comprising our Credential of Readiness (CORe) program—which teaches the key financial topics needed to understand business performance and potential. Not sure which course is right for you? Download our free flowchart.
