The Importance Of Project Budgets
As a business owner, you probably understand the importance of budgeting, particularly for the construction industry.
A budget helps construction companies forecast their expenses and cash flow. With this information, you can ensure your finances adequately meet your short-term goals, and you can also set long-term goals that align with your budget.
It’s important to remember that cash on hand isn’t enough. While you may have thousands of dollars in the bank, you may have just as many—or more—upcoming expenses. All too often, business owners review their cash flow and assume they’re doing well. Unfortunately, this often leads to overspending, which creates a cash flow shortage later in the month or year.
As you’re budgeting, it’s important to ask yourself a few essential questions:
- What are my upcoming expenses this month?
- What will my expenses be later this year?
- Do I have plenty of revenue now?
- Do I have adequate revenue for the next year?
- Do I have projects lined up for the next month? Three months? Year?
- When is my busy season? When is my downtime? Do I have enough savings to get through the downtime?
Accurate budgeting is difficult for any industry, but it’s even more difficult for contractors. You’re often juggling multiple contracts at once, and you’re often struggling to pay for materials and labor without seeing any profit yet.
That’s why a budget is crucial. It helps you clarify your current financial position as well as project your future. It helps you identify your shortages and plan ahead so cash flow is never an option.
Ideally, you’ll have a budget for each individual job. Even more importantly, though, you should have an overall business budget, and you should review this budget regularly to make sure you’re on track. Here’s how.
The Types of Construction Budgets
First, let’s consider the different types of budget you can use.
Zero-Based Budget (ZBB)
Many experts tout the benefits of a zero-based budget. Here’s how it works:
First, you determine your budgetary time period. Usually, this is a year, but you can set a monthly budget or even a quarterly budget if you prefer. Then, you list all your revenue and expenses for that period, using your best estimate based on prior records and upcoming projects.
It’s called a “zero-based budget” because you’re starting the budget with 0 and ending with 0, as well. You’ll assign all of your anticipated revenue to a budget category until there’s no money left. Each period, you’ll create a new budget because you’re starting from 0. This forces you to look at all of your expenses objectively and really focus on the ones that drive your revenue. Usually, a ZBB helps the company save money and encourages owners to be more aware of their finances.
You’re probably most familiar with an incremental budget. Unlike a ZBB, the incremental budget uses the last period’s budget as its foundation. Generally, you take the prior budget and increase categories by a specific amount or percentage—hence the name, “incremental” budgeting.
So, for example, you might expect revenue to grow 5 percent year-over-year. In this case, you would take last year’s budgetary revenue and increase it by 5 percent. If you expect expenses to also increase by 5 percent, you would do the same for those.
As you may imagine, this type of budget is much simpler than a ZBB, but it’s usually not as accurate. It also leaves more room for error. Still, it has its advantages. If your construction business is quite large or expenses are especially difficult to predict, an incremental budget may be the best way to go
The project budget is a job-by-job breakdown of expenses and revenue related to each specific job. You should create a project budget for all of your jobs, if possible, but pay particular attention to your larger jobs. These often scale well beyond what you originally intended, and it’s easy to lose all your profit if you don’t keep track of expenses.
A project budget is a lot like a ZBB, with one key difference—the end result shouldn’t be 0. Estimate your revenue for the job, then list all of the expenses. The remainder is your profit. If there isn’t a remainder (or if the number is negative), you’re losing money on the job. In this case, it’s best to look at your job estimates to find the discrepancies.
While many business owners focus on financial reports like cash flow and balance sheets, your budget is also incredibly important. If you want to meet your financial goals and increase your overall revenue, you need to keep a firm grasp on your expenses, ensuring they never increase beyond your revenue.
Think of your budget as your road map to success. Are you on track now? Will you still be on track if you hire new employees or move to a larger office? Are there ways to reduce your material expenses so you make a bit more profit with each job?
A Chief Financial Officer (CFO) can help answer these questions for you. CFOs create budgets and ensure forecasts align with your business goals and objectives. If you’re not in a position to hire a full-time CFO at the moment, consider working with Daaxit instead. We work with construction firms to ensure they’re positioned for success. Contact us to learn how we can help you today.