The Right Way To Budget For a Company 2022 [With Template!]
Plan for profit, and work your way up.
We recently wrote a blog post about the traditional way (Top-Down Approach) of creating a business budget for 2022.
We don’t recommend reading it.
Not because it’s wrong per se, but because we believe there’s a better way to budget for your business next year, a way that drives profitability and enterprise value.
It’s called the Bottom-Up Approach. Or at least that’s what we’re calling it here.
It’s the method we use with our clients here at U-Nique Accounting, as it takes into consideration the realities and growing pains of a business that traditional budgeting methods leave out.
In this blog, we’re going to walk through our preferred method for budgeting a business, and share a free template for you to use next year.
Let’s get started.
Business Budgeting: The Bottom-Up Approach
The traditional way of doing things isn’t always the best way, and budgeting is an example of that.
While you may choose to continue with the Top-Down Approach (revenue – expenses = profit), we prefer to use a “Bottom-Up” approach that focuses on profit and business value, rather than revenue.
In other words, plan for the profit you’ll need, not what you’ll make in sales.
Here’s a quick breakdown:
Traditional Budgeting Method – Decide sales levels first and calculate resulting net income
Preferred Budgeting Method – Decide net income levels first and build up to the required sales levels
The Bottom-Up Approach is the superior method to forecasting as it sets a minimum level of profitability required to achieve company goals.
Need cash for capital investments? Working capital? Loan repayments? Retirement planning?
You need to plan for it, and this method will help you do just that and let you know if the business can support all your cash flow needs.
Quick Steps to The Bottom Up Approach
Follow these quick 5 steps to get started. If you need help, you can reach out to us here at any time. We’re here to help.
1. Review short and long-term factors
Take into consideration both professional and personal goals.
First, take a look at what’s happening in your business, short and long-term.
What do you need to factor into your finances?
- Are you growing rapidly? You may need a lump sum of cash to expand your team quickly.
- Are your working capital reserves depleted or below where it needs to be? What is needed to build this balance back up to a safe level
- Is your equipment in dire need of replacing? You may need to borrow and maintain ongoing repayments.
Second, take a look at your personal goals
- Have you been underpaying yourself and need to increase your compensation structure?
- Have you saved enough to help cover college tuition for your family?
- Do you need to save more for retirement?
- Are you planning for an exit, and need to meet an ideal EBITDA figure?
List all of these, and other, factors out and determine what annual amounts the business cash flow needs to provide, before even reaching for the spreadsheet.
2. Determine profits required
Next, determine the profits you’ll need next year to generate the cash flow required for the factors above.
3. Build from the ‘bottom up’
Once you’ve determined your ideal net income, build ‘up’ the spreadsheet to determine the sales levels needed to achieve this.
Profit –> Operating Expenses –> COGS –> Sales
4. Analyze the numbers
How does it look? Based on your win rate and required sales pipeline/bidding activity, are your sales levels realistic for the trajectory of your business next year? If they are great! If not, then go to step #5.
5. Dial it in
If the sales numbers look too high, play with the business dials – gross profit and overhead.
What can you rein in?
Dial #1: Overhead and other indirect expenses
First start with your overhead. This dial has the biggest impact on your required sales level. For example, if you have a gross margin of 10%, then a $1 savings in your operating expenses is equivalent to increasing your sales levels by $10.
Do a thorough review of your operating expenses (read our cash flow guide blah blah blah…) and come up with a reduced value.
If your new adjusted required sales level is still unrealistic, then turn to dial #2.
Dial #2: Gross Margin
After scrubbing through and reducing your overhead expenses, take a look at your gross margin. This dial does not have the same impact as tweaking your overhead dial, but it still has a bigger impact than focusing on sales.
For example, if your current budgeted gross margin $ are $100,000 and your gross profit % is 10%, then your required sales level to achieve your $100,000 of gross margin is $1,000,000 of sales. If you were to improve your gross margin by 1% (increase from 10% to 11%), then your required sales level would drop from $1,000,000 down to only $909,091.
Once you have adjusted and squeezed as much gross margin as possible, if your sales levels are still unrealistic, then as a last resort, turn to dial #3.
Dial #3: Business and Personal Goals
As a last resort, you can lower your net income goal – just keep in mind that this will affect your long-term planning.
While it’s always encouraged to aim high, this is one of the times you want to remain practical.
Be realistic with what your team can achieve. Review your business and personal goals and make some hard adjustments to your short and long-term plans.
We recommend working with an accountant before reaching this point to ensure you stay on track with your long-term goals.
Download Your Free Budget Template
To make things even easier, we created a budgeting spreadsheet for you to use.
Simply download the Budgeting Spreadsheet here and follow the steps above.
How easy is that?
By using our budgeting spreadsheet and our preferred Bottom-Up Approach, you’ll have the spare cash required to hit personal and professional goals next year, and grow your business flexibly.
Get Additional Help With Your Business Budget 2022
Whether you give the Bottom-Up Approach a shot or revert back to the traditional method (we won’t judge!), budgeting is always tricky.
Undershoot your cash requirements, and you may end up squeezing for cash throughout the entirety of next year.
Overshoot, and you may risk underachieving your long-term growth goals.
That’s why we always recommend getting help from an expert.
At U-Nique Accounting, we help business owners like you plan and forecast for their business growth each year.
If you’d like help with budgeting, or another financial process within your growing business, feel free to book a 15-minute call with us anytime.
Simply use our calendar to start.
Until next time!