A Step-by-Step Guide
A well-crafted 3-year business budget is vital for planning and managing your business's financial health. It helps you set realistic goals, allocate resources effectively, and track your performance over time. It will be a detailed forecast of revenues and expenses, considering your company's goals, expected growth, and market conditions. Here's a step-by-step guide to creating a comprehensive 3-year budget:
1. Gather Financial Data
- Review Past Performance: Review the last 1-3 years of Profit & Loss statements, Balance Sheets, and Cash Flow statements. This will help identify trends, patterns, and areas for improvement and give you a baseline from which to forecast.
- Bookkeeping and Records: Use your current bookkeeping system (such as QuickBooks Online) to categorize expenses and income accurately.
- Identify KPIs: Analyze your past financial statements to identify your KPIs. Determine the key metrics that will help you track your business’s performance, such as revenue growth, profit margin, and customer acquisition cost.
2. Set Revenue Projections
- Sales Forecast: Estimate revenue for each of the next three years. Break it down by month, quarter, or year, depending on your business cycle. Identify the sales channels you'll utilize and estimate the revenue from each. Take into account:
d. New product lines or services
e. At the end of this article, there is a significant pointer that you will need for this.
- Growth Rate: Apply an appropriate growth rate based on historical performance and industry standards.
- Pricing Strategy: Consider your pricing strategy and any potential price adjustments.
3. Estimate Fixed and Variable Costs
- Fixed Costs: These are expenses that don’t change with the level of sales, such as rent, salaries (excluding commissions), insurance, etc.
- Variable Costs: These fluctuate with production or sales levels, such as raw materials, shipping, sales commissions, cost of goods sold (COGs), marketing, utilities, etc.
- Changes Over Time: Consider factors like inflation, expansion plans, or new hires, which might increase costs in future years.
- Operational Expenses: Allocate funds for day-to-day operations, including office supplies, travel, and professional fees.
4. Plan for Capital Expenditures
- Major Expenditures: Include significant purchases (equipment, technology upgrades, facilities, etc.) in the budget. These are often significant, one-time costs that could impact cash flow.
- Debt Obligations: Account for any loan repayments or financing you might need for these purchases.
5. Cash Flow Forecasting
- Cash Flow Forecast: It helps you ensure that you have enough liquidity to cover operational costs even during periods of high spending (e.g., capital purchases).
- Components: This includes incoming cash (sales, investments) and outgoing payments (operational expenses, debt repayments, tax payments). Basically, don’t neglect Cash Outflows, Cash Inflows, and the Net Cash Position.
6. Budget for Taxes
- Tax Obligations: Estimate this based on your projected profits, including potential changes in tax rates or new tax policies.
- Don’t Forget: Federal taxes will be your main focus, but don’t forget your state and local county or city taxes.
- Payroll Taxes: If you have employees in multiple states, remember to consider them.
- Other Taxes: This will include retail sales taxes, annual company reporting taxes (the corporation filing, not the income tax), and other taxes.
7. Sensitivity and Risk Analysis
- Scenario Planning: Create optimistic, pessimistic, and baseline scenarios to assess the impact of different factors on your financial performance.
- Risk Assessment: Identify potential risks and develop contingency plans.
8. Contingency Planning & Multiple Models
- Contingency: Set aside 5-10% of the budget as a contingency for unexpected expenses or economic downturns. This will give your business a cushion for unplanned events.
- Macroeconomic: Give provisions for an unforeseen event like the previous COVID event or a significant recession. Put a number on it.
- Best-Case/Worst-Case Scenario Models: Prepare different financial models for optimistic, realistic, and pessimistic projections. These will help you anticipate possible outcomes and adjust your strategy accordingly.
9. Funding Requirements
- Determine Funding Needs: Identify the funding required to support your growth plans.
- Funding Sources: Explore various funding options, such as loans, equity investments, or grants. Necessary: start gathering names and companies that may provide you with funding, and build relationships from there. If you wait until you need the funds, when you approach them as a new relationship, they may be more reluctant to give you the loans you need or will ask for major inconvenient covenants.
10. Review and Adjust
- Monthly or Quarterly Reviews: Once the budget is in place, compare actual performance with your budget regularly (monthly or quarterly) to adjust forecasts and ensure you’re on track. DO NOT skip this. Things will continually change.
- Rolling Budget: Update your 3-year plan each year so you always have a rolling 3-year budget to account for any changes in market conditions or business strategy.
- Monitor Performance: Track your actual performance against your budget and adjust as needed.
Tools & Resources:
- QuickBooks Online or Xero (for small businesses): Sync your accounting with budgeting software to align your forecast with your actuals.
- Excel or Google Sheets: These are useful for building custom financial models, especially if you want to be flexible with your assumptions.
Additional Tips:
- Collaborate with Your Team: Involve key stakeholders in budgeting to ensure buy-in and accountability.
- Seek Expert Advice: Consult with accountants or financial advisors for expert guidance.
- Be Realistic: Set achievable goals and avoid overly optimistic projections.
- Stay Flexible: Be prepared to adapt your budget as circumstances change.
How and Where To Start?
You start with Unit Economics, which will be your crucial first step in a 3-Year Budget plan.
- Unit Economics: It measures unit cost, pricing, and net. For example, there were many industry studies about the Apple iPhone. One significant report was an infographic where the writer used the actual iPhone picture and went from the bottom up, indicating all the % of the costs associated with producing a single iPhone and eventually ending up at the top of % list of the iPhone was the Apple’s Net Profit from every single iPhone.
- Your CFO, Controler, or Finance Manager: Ask them to help you with this Unit Economics exercise. If they don’t know or seem befuddled, FIRE them and hire another person or company to help you with your budget plan.
By following these steps and using the right tools, you can create a comprehensive three-year business budget that will help you achieve your financial goals. While many of the pointers mentioned above may seem like a very small sum, if you ignore them, their combined effect could determine whether you will be profitable or not in the future.
Would you like to explore a specific aspect of budget preparation further, such as forecasting sales or managing expenses?
