Effective planning is critical for any business and the P&L budget is one of the many planning tools that leaders rely on. The use of the P&L budget often extends beyond planning and is sometimes used by lenders and investors as well. In the context of CPM, P&L budgets sometimes get confused with forecasts. While the two are similar it is important to note the differences between budgets, which is a plan, and a forecast which is a model of the future.
In this FAQ we will discuss what a P&L budget is and its different elements, how it is used and why it is important, and how to make one.
What Is A P&L Budget?
P&L stands for profit and loss and is in reference to the net income of a business. Therefore, a P&L budget is a type of budget that outlines the plan for profit and loss that the business expects to experience. Keep in mind that a budget is a financial plan, which is distinctly different from a forecast.
The main difference between a forecast and a budget can be equated to the difference between a map and a compass. Where a map is an overall guide that reveals what direction you need to go, the forecast acts as a compass letting you know if you are going in the right direction.
The P&L budget is one aspect of the overall budget. Once a budget is created, it is often used as a basis for forecasting what the future period should look like. In this way, budgeting and forecasting are two complementary tools that should always be used in tandem.
One of the primary elements of the P&L budget is that it provides the sales expectations for the upcoming year. This is especially helpful when viewed in the context of the overall budget, in which you can analyze if there are sufficient resources in areas like marketing and sales, to execute the P&L budget.
Another key element of the P&L budget is that it presents overall income and net income expectations. The P&L budget represents all of the elements of the income statement and as such, it can be used to create various metrics and financial ratios that can be used to monitor the business.
Why is The P&L Budget Important?
The P&L budget acts as a guide for two important things: sales targets and expense targets. Managing both is important for any business. It is frequently used to assist sales teams with setting department budgets for things like marketing and funnel development.
In doing this it indirectly creates information that helps leaders to decide if operational changes are required to support increased sales. This again helps set the budget for other expenses and ensures that the resulting plan is realistic and attainable.
Another helpful aspect of the P&L budget is its ability to create target metrics that can be used in KPI dashboards. Because it is created in the image of the P&L statement, the budget can be used to generate target metrics.
Lenders and investors often rely on P&L budgets to help assess risks. They are used to prove that the business has a realistic and well-thought-out plan to execute on. This helps instill confidence in both lenders and investors that the management team is capable, and that the business is a going concern.
How To Make A P&L Budget
Before beginning it is important to have a firm grasp of the organization’s current income and expenses. Understanding this information helps to ensure that the plan is realistic.
This first step is to create an overall business plan with quantifiable goals. For example, a plan might be to increase revenue by 10%, through the use of new marketing tactics. Once a plan is created with quantifiable outcomes and goals, those goals can be incorporated into the P&L budget.
Second, decide your budget methodology. The four primary methods of budgeting are incremental budgeting, activity-based budgeting, value proposition budgeting, and zero-based budgeting. Understanding each method will help you select the best one for your budgeting needs.
Next, create your P&L budget, or what your income statement will look like based on the methodology you have selected. The P&L budget should represent the income statement. Be sure to forecast each line item including gross revenue, cost of goods sold, variable and fixed expense, and depreciation and amortization.
Once you have generated a value for each of the statement line items the P&L budget is complete. Use the budget to monitor and perform variance analysis.
Using DataRails, a Budgeting and Forecasting Solution
DataRails’ FP&A solution software replaces spreadsheets with real-time data and integrates fragmented workbooks and data sources into one centralized location. This allows users to work in the comfort of Microsoft Excel with the support of a much more sophisticated data management system at their disposal.
Every finance department knows how tedious building a budget and forecast can be. Integrating cash flow forecasts with real-time data and up-to-date budgets is a powerful tool that makes forecasting cash easier, more efficient, and shifts the focus to cash analytics.
Regardless of the budgeting approach your organization adopts, it requires big data to ensure accuracy, timely execution, and of course, monitoring.
DataRails is an enhanced data management tool that can help your team create and monitor cash flow against budgets faster and more accurately than ever before.