10 Tips for Creating Your 2011 Budget

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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With the holiday season fast approaching, it's time to start finalizing your plan for the upcoming year. Regardless of how the economy has impacted your business, planning and budgeting for 2011 will help you maximize your results, hopefully propelling you even faster toward the desired objectives for your business.

Many businesses don't bother to put a budget together each year. They claim they have no control over the future and projecting is no more than a wild guess. Not only are they wrong, but they will also miss out on unique competitive advantages that can only be gained by disciplining the business to this annual practice. If you've never budgeted before, then I encourage you to start now. If you're an old pro at it, then please keep up the work.

I've compiled a list of ten tips (plus a bonus eleventh tip at the end) to add value to your budgeting process, whether you're a novice or an experienced budgeter.

1. Start now

It's November. The new year is less than two months away. You need to start thinking about how the year is going to shape up now, giving yourself plenty of time to create at least a few budget drafts until you're comfortable with your plan. This is not a process that you spend 15 minutes on once per year. You will want to create your first draft, take a little bit of time away from it, and then re-engage to start tweaking and improving it.

2. Think like your general ledger

Your budget will be most meaningful if you organize it the way your general ledger (or chart of accounts if you are a QuickBooks user) is organized. In addition, an annual budget with no monthly details will not be very helpful. With a budget organized by account and broken into months, comparing your actual performance to your budget will help you gain the strategic insight this process should provide.

3. Know your marketing metrics

How about we project sales to increase 7% for next year? Sounds reasonable, right? Not really. You need to dig into what it would take to generate that increase. How much more will you need to spend on marketing, and in which marketing activities, to generate that increase? And my guess is a 7% increase in traffic to your website will not increase your revenue as much as 7%; marketing metrics are not usually that perfectly correlated.

4. Use CPA and conversion stats

With your marketing metrics in place, now you can determine what your cost per acquisition (CPA) will be for the year. Is it higher or lower than last year? Is it reasonable? With your traditional and expected conversion rate per marketing activity, you can determine your entire marketing budget for the year along with the revenue you expect that marketing spend to create.

5. Refer to last year, but don't rely on it too much

I have a few pet peeves when it comes to budgeting. One of them is increasing everything by a percentage and assuming your budget is done. It's just not that easy if you really want to make budgeting worthwhile.

6. Dial in the cost of goods and services

With sales projections in place, you can now build in the "cost of goods/services sold" part of your model. You should have a target gross margin you are trying to achieve, and your assumptions need to validate where you're going to be relative to that gross margin. If you're planning to do better than your target, then you should have a clear reason why. If you are going to do worse, then you should again know exactly why and plan accordingly.

7. Separate fixed and variable overhead

Break all of your costs, by account, into one of two categories as best as you can — fixed and variable. This is not always as easy as it sounds, but looking at the last two-to-three years of your performance can be an indicator if the cost has stayed relatively the same as revenue fluctuated or if it seems to have had some correlation to fluctuating revenue.

8. Find drivers for each account

With your costs broken out into these two categories, you need to figure out what the driver is for each cost in your business. Is it employee headcount? Number of vehicles? Whatever it is, tie it to that driver and then make your driver assumptions easy to find so you can change those assumptions quickly, making it possible to look at what/if scenarios.

9. Don't forget the balance sheet and statement of cash flow

Once you've done all of this assuming and projecting, you're only a third of the way complete. You have completed your profit-and-loss plan on a performance, or accrual, basis, but now you need to determine how that will impact your balance sheet and, ultimately, your statement of cash flow. Please allow me to restate: If you only project your profit and loss statement, you are missing one of the most important parts of budgeting — understanding the impact of your plan on cash flow.

10. Create best- and worst-case scenarios

Every business should attack the new year with realistic, best-case, and worst-case budgets. Once you finish with your most realistic version of 2011, make some assumptions around the best and worst things that could happen during the year and project the results in a high and low budget.

Bonus: Compare, analyze, and adjust

Now that your budget is complete, it's useless if you set it aside and charge through 2011, never looking at or referring to it. You will get the most benefit from your budget by comparing your performance against your plan for each account every month. The insights you gain as you understand which assumptions were right and which ones were wrong will only be part of the value you receive. Your ability to tweak those assumptions will empower you to handle and appropriately react to any challenges or unexpected changes to your plan throughout the year.