Consider, before getting started, the following:
- Who is your budget for? Is it to apply for a bank loan, to keep managers aware of sales targets, or for yourself to ensure you stay on track with what you’re doing?
- What do you want to achieve with it? Eg. is it a target, projection or constraint?
- Your timeframe
- What are you forecasting? Are you a SaaS or product-based company?
- When in your company’s lifecycle are you doing this?
We’ll be exploring the two main ways of approaching budget: top-down budgeting vs bottom-up budgeting. But what are they and which is best?
Option 1: top-down budgeting
As the name suggests, you’re laying out a budget of how much you can spend – a top level – and then attempting to spread that across all needs. You’re considering the money you want to spend. For example, if you can spend £80k next year, you need to ask yourself how you’re going to make that work across the timeframe and departments. You’re setting a spending limit and sticking with it for all of your expenditures.
Option 2: bottom-up budgeting
This means you’re setting out all the things you’re going to spend your money on, then adding it all together to equal your expenses. Doing this, you’ll be able to work out if you’ve set aside enough to meet your end objectives. This often goes hand-in-hand with zero-based budgeting, which means you are going to spend zero unless it helps with your objective or mission.
Pros and cons
Our in-house Management Accountant, Daniel Killoran, says bottom-up budgeting is often best practice, as it makes you think about what exactly all the costs of running your business are.
The bottom-up approach helps you prevent your budget from becoming too unrealistic, which can be detrimental, especially if you’re holding people to account and bonuses, etc, are linked to it. Bottom-up budgeting makes you question every spend but it might not give you the profit you want.
On the other hand, you may find you need to make what cash you have work, which is when top-down would be better.
You’re essentially setting yourself a stricter target, forcing yourself to spend less. It’s a hard goal put against what you’re going to spend. For example, if you know what you spent last year, you can quite easily predict what you’re expecting to spend this year.
If it’s your first year in business, it may be harder to keep control of top-down budgeting as you’re not as aware of what to expect to pay out.
Where will it work and where will it fall flat?
If you operate with an MRR model, for example, forecasting from last year’s actuals wouldn’t work. This is because your sales would likely increase, though projections from last year’s actuals wouldn’t show the right data.
If you don’t have previous data, force yourself to build it from the bottom up. What would you need to spend to support the revenue? There are a few different ways to do this for your revenue but it depends on the industry.
A software company, for example, would need to think how many packages they might sell, which could be based on prior data or their targets, but that might be different to what’s expected.
If we say they’ll sell X amount of packages at £100, they’ll need to build a formula into Futrli then they can play around with prices.
So if you’re early stage, it’s good to build the formulas in and play around to see how sensitive it would be to changes in units or sales price. For example, it might be 50 units x £100, but you’ll want it to increase so you’ll need to bring in non-financial data. This data can be anything without a monetary value, so have a think about what could impact your business in this way and add it in – the more information you can add, the better.
Revenue needs to be approached differently to expenses.
Things to consider are:
- Trading history. If you have this data, it’s best to use it.
- Who is the budget for. If it’s for a bank loan, for example, it’ll be different to your personal one. Ideally, you’ll have two different budgets: one for yourself and one for others in your organisation that guides their behaviour towards your end goals.
- What you’re selling. If you create a physical product, for example, the cost of sales would be a % of your revenue. But if it’s subscription model like SaaS, for example, the cost of sales are going to decrease as time goes on, as you’re going to have more revenue, as every new pound bought in costs less to support.
Start with your expected revenue, and the costs that will support that is one way. Starting with the profit you want to achieve, seeing if there’s a way to make that work with costs and revenue. The more detailed the better, the more you go into units and prices the more realistic it’ll be. Work out every little factor and cost for revenue that comes in.