What Is a Financial Budget? (And How To Create One in 6 Steps)

By Indeed Editorial Team

Published April 2, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

One of the simplest ways for an organization to be financially responsible is by creating a budget. Financial budgets estimate revenue and expenses and guide an organization's spending over a specified time. Implementing a financial budget can help your organization increase profits and have enough money for its expenses. In this article, we discuss what a financial budget is, list its benefits and explain how to create one.

Related: Differences Between a Financial Analyst vs. Budget Analyst

What is a financial budget?

A financial budget is a microeconomic concept that organizations use to estimate their revenue and expenses. Budgets usually track these metrics over a specified time to determine the organization's financial performance. If a budget is in surplus, it predicts the organization to profit. A deficit budget is when expenses exceed revenue, and a balanced budget occurs when expenses equal revenue. Ultimately, a budget helps an organization allocate its resources to remain profitable and reduce debt.

Related: Budgeting Report: Definition, Template and Examples

Benefits of creating a financial budget

Here are some benefits of creating a financial budget:

Increase profits

A financial budget requires an organization to evaluate its total revenue. Understanding how much money comes in can help the organization recognize new income opportunities, such as charging more for a product or marketing to a new demographic. Budgets also help organizations reevaluate their expenses and find cheaper vendors, allowing them to increase their profit margins. Ultimately, these increased profits can help an organization scale its operations and create more ambitious goals.

Make timely payments

Because a budget allocates funds to certain expense categories, it can help organizations make timely payments. For instance, a budget ensures an organization has enough money to pay employee salaries. These consistent payments can reassure team members of job security and boost overall morale. Organizations also use their budgets to guarantee vendor payments. These payments ensure the organization maintains good relationships with vendors and receives the necessary supplies for producing goods.

Prepare for tax season

When an organization is profitable, it might use its income to invest in new equipment and expand its operations. These ventures can help facilitate growth, but it might result in the organization not having enough money for overlooked expenses, such as taxes. Organizations that can't pay their taxes may face legal troubles and hefty penalties, but they can prevent these issues by factoring taxes into their budgets.

Reduce debt

When an organization has significant loan payments and credit card debt, the interest payments can reduce overall profits. Budgets help organizations allocate funds to reduce their debt. The quicker an organization can pay off its debts, the less interest it has to pay and the more money it has to fund other operations.

Related: How To Plan a Budget Analysis (With Tips)

How to create a financial budget

Here are steps you can use to create a financial budget:

1. Determine the organization's goals

Consider the organization's goals and ensure they're measurable and actionable. Knowing what your organization wants to achieve can help you account for necessary expenses later in the budget-creating process. For instance, a small business might want to increase sales by $50,000 per year. Another company might want to improve one of its products by adding a new feature or connect with new customers by expanding its marketing campaign.

Related: How To Prepare a Master Budget (With an Example and Tips)

2. Calculate the organization's average growth rate

While there are various ways to forecast sales, one of the simplest methods is using historical data. Analyze the annual sales of your organization during previous years and calculate the average growth rate. For instance, imagine a company had the following sales in its first four years:

  • Year one: $100,000

  • Year two: $120,000

  • Year three: $130,000

  • Year four: $137,000

You can calculate the growth rate for each year by dividing a year's sales by the previous year's sales, subtracting one and converting the decimal to a percentage. For instance, the growth rate between year one and year two is (120,000 - 100,000) - 1 or 20%. Then, you can find the organization's average growth rate by dividing the sum of the yearly growth rates by the total number of growth rates. In the example above, the average growth rate would be (20% + 8.3% + 5.3%) / 3 or 11.2%.

3. Forecast sales

Forecast sales for the next year by multiplying the previous year's sales by the organization's average growth rate and adding this number to the previous year's sales. Consider the example above and imagine the organization wants to create a budget for year five. You could multiply year four's sales, $137,000, by the average growth rate, 11.2%, to get $15,344. The equation for this is $15,344 + $137,000 = $152,344, which is the projected year five sales.

4. Calculate expenses

Finally, you can estimate the necessary expenses your organization requires to operate profitably and reach its goals. Expenses that apply to almost all organizations include fixed costs like rent, employee salaries and insurance. You can also consider variable costs like utility payments, business meals and raw materials. Determine how much the organization currently spends on these categories and note if there are savings opportunities. For instance, you might research vendors to find a cheaper provider.

Related: Budgeting vs. Financial Planning: What's the Difference?

5. Divide your budget into expense categories

Divide your budget into expense categories and assign a percentage of your budget to allocate to each category. The value of the percentage depends on how essential the category is to the successful operation of the organization. For instance, you might assign a higher percentage to the marketing department if the organization plans to increase its advertising efforts for the year.

6. Calculate projected expenses

The final step is to calculate projected expenses by multiplying the percentage of each category by the projected sales. For instance, imagine the projected sales of a company are $150,000. If the accounting expense category is 5% of the budget, the organization can spend a yearly amount of $150,000 x 5% or $7,500 on accounting-related costs. You can repeat this process for the remaining expense categories, and the leftover sales money is the organization's profits. Note that it's important for an organization to adhere to these spending limitations for each category to ensure profitability.

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