Many small business owners seek information for both their business and personal budgets. My new article is a thorough guide to budgets and projections specifically for businesses.
Why is it important for a business owner to have a budget?
- Manage your cash flow for payroll and vendor/supplier payments.
- Determine new business investment opportunities for increasing profit margins.
- Match expenses to revenue to ascertain if there is enough money to adequately fund operations.
- Decide if/when you need to apply for financing and/or working capital.
- Identify cost-cutting measures, if needed.
- Concentrate resources to fund current business commitments.
- Make continuous improvements and anticipate problems.
- Motivate staff, assuming the budget is shared with all employees.
- Plot the financial future of your small business.
- Enable the understanding of the financial health of your business, including the break-even point.
- Improve decision-making to keep the business on track with your objectives.
- Estimate, in some detail, business revenue and expenses for a specific period.
- Provide control and targets for the business’ functions, processes, and operations.
- Reduce risk of spending more money than receipts or, conversely, not spending enough to grow.
- Allow comparison of actual; income and expense activity with budgeted amounts.
- Find keys to flexibility, business success, and scaling.
What Guidelines Should be Followed to Employ Budgets to Drive Success?
- Look at your budget regularly; your business is not static and the budget should not be either.
- Spend time creating your budget; use last year’s figures for direction; and develop a realistic one.
- Review the budget monthly with your management team, based on info from the prior month.
- Compare budget figures against actual at least quarterly, but preferably monthly - adjust as needed.
- Analyze reasons for shortfalls in revenue, high turnover, and mismatches of income with expenses.
- Define the relationship between sales and the various costs; then, use estimated sales to project costs.
- Consider creating a budget for each product or service you sell to evaluate profitability of each.
- Update the business budget with revised forecasts, especially in the cashflow area.
- Monitor key drivers of the business: Sales, costs, and working capital.
- Buy software such as QuickBooks, which has great planning/budgeting tools.
What Should the Budget Include?
- To begin the budgeting process, the business owner needs to quantify the answers to the following questions for the budget period:
(a) What are the projected sales;
(b) What will be the costs to produce that level of sales; and
(c) What are the fixed (overhead) costs to operate the business? - One generic formula to compute might be:
(a) Gross Revenues minus Cost of Sales equals Gross Profit – minus
(b) Fixed Expenses minus Variable Costs equals Income before taxes -minus
(c) Income and business taxes equals Net Income - For revenues, the owner can use figures based on recent trends in the business. If the business is a start-up, then assumptions and estimates for sales based on target market, pricing, and product popularity must be made.
- Next, determine a weekly or monthly amount for the fixed/operating costs – items that must be paid regardless of sales. Examples are: facility and equipment rentals/leases, utilities, payroll taxes/fees, loan interest, insurance, advertising/promotion, marketing/networking, meals & entertainment, telephone, Internet/hosting, website, travel, professional fees, supplies, computers and accessories, licensing, business state/local fees, training and education, bank charges, printing, postage & delivery, dues/subscriptions, publications, and local transportation.
- Variable costs are those related to amount of sales, such as commissions, raw materials, labor, overtime, and inventory and are categorized as Cost of Sales or Costs of Goods Sold.
- In some industries, operating expenses such as for equipment, computer systems, payroll, and utilities may be variable depending upon the sales season and/or cycle. Be sure to consider any budget changes required based on volume increases/decreases, if applicable.
- Once the owner knows the budgeted pre-tax income, income and business taxes must be gauged and included in the budget.
- Factor in some slack for operating difficulties and/or uncontrolled events by making conservative, but practical financial approximations for budgeting purposes.
- Incorporating a cash flow projection chart into the budget, which is based on YTD cash balance, is a crucial component. Analysis of the projected cash in/out flows for the upcoming months in the period must be part of the actual versus budgeted monthly review of the revenues and expenses.
- Ensure that there is an emergency source of capital available, in the event it should be needed.
How Should the Budget be Reviewed and Maintained?
- If you use Excel:
(a). Income/taxes/expenses should be the row headings, with the months the columns ones.
(b). Allow three columns for each month – one for budget, actual, and difference.
(c.) Subtotals are useful to group income, taxes, and the two types of expenses.
(d.) Input the budget figures for all months to start.
(e.) As the months pass, input the actuals, calculate/review the variances monthly or quarterly.