5.12 – More Important Ways You Can Use Budgets
When preparing budgets, it’s essential to remember that the data and information collected can support various other business planning and management functions. Here are some key ways you can utilize well-developed budgets:
Estimating Taxable Income
A well-developed budget can help prepare forecast financial statements and estimate the taxable income or loss of a company. For some companies, the difference between book and tax income is small, while for others, it can be significant. Consider this example:
A large personnel services provider decides to self-fund its workers’ compensation insurance costs, anticipating annual savings of 30 percent or more. After three years, the company accrues a liability of over $1 million for potential future claims, reflecting this as an expense in its financial statements, resulting in net income of roughly zero dollars. However, for tax purposes, the IRS does not allow the expense until the claims are paid, making the company’s taxable income $1 million, leading to a $400,000 tax liability. Without proper budgeting, the company might face an unexpected $400,000 tax bill, despite appearing to break even.
Securing Capital and Developing Business Plans
Budgets are crucial when developing a business plan, especially if a company is seeking capital. Financial forecasts act as a numeric display of the company’s vision and outlook. When presented effectively, these forecasts enhance the credibility of the management team and the business plan, reducing barriers to acceptance from potential funding sources. Essentially, financial forecasts must clearly tell the “story” of the business.
Supporting Specialized Needs
Budgets can also serve specialized needs, such as:
- External Requirements: Preparing specific information requested by external parties.
- Training: Educating new store managers on the basic economics of their store to ensure alignment with the company’s vision.
Enhancing Business Value
The better a budget is designed and structured from the beginning, the more uses and value it will provide your business in the long run. Here are some additional benefits of a well-structured budget:
- Strategic Planning: Helps in setting realistic goals and developing strategies to achieve them.
- Resource Allocation: Ensures efficient allocation of resources to different departments and projects.
- Performance Monitoring: Assists in tracking the company’s performance against its goals and making necessary adjustments.
- Risk Management: Identifies potential financial risks and prepares the company to mitigate them effectively.
Conclusion
A well-developed budget is a versatile tool that goes beyond simple financial planning. By utilizing budgets for estimating taxable income, securing capital, supporting specialized needs, and enhancing overall business value, you can significantly improve your company’s financial health and strategic planning. Investing time and effort into creating a detailed and flexible budget will pay off by providing invaluable insights and support for various business functions.
