WHY You Need a Budget
Any small business owner intent on planning a successful future for his or her business must take into account how to fund that plan. Simply put, a budget outlines what you will spend your money on and where that money will come from. It projects your income and your expenses and sets a profit goal. It lets you know, at any point in time, how well - or how poorly - your business is doing.
Without a budget, you will find it difficult to manage your business, control your cash flow, allocate the necessary resources to meet your objectives, measure your progress, or invest in new opportunities that may arise. By carefully crafting a budget, you give yourself an important management tool to guide your daily actions. You also obtain a "financial picture" of your future. A budget permits you to better identify problems before they occur and, if need be, alter your course of action.
WHEN to Develop a Budget
You will need a budget as you formulate your business plan. In fact, as pointed out by the Small Business Administration's (SBA) Online Women's Business Center, "the first budget you prepare often uncovers problems with your plan and helps you determine whether or not your financial goals are within reach." In other words, calculating your sales projections and production costs will help to focus your thinking and choose a plan of action that is realistic and achievable. You'll definitely need a carefully crafted budget before seeking and securing funding for your start-up. And, as the SBA recommends, you should create a budget before investing money in new equipment or other assets and before signing leases.
WHAT to Include in a Budget
A budget is a forecast of your "Money In" and "Money Out." It should indicate:
- Your total start-up costs;
- The amount of cash required for necessary labor, materials and other expenses associated with day-to-day operations;
- Sales and other sources of revenue needed to support the operation of your business; and
- Expected profit
BASICS of a Budget
Keep it simple, but realistic. Budgets don't have to be complex and compiling one needn't be an act of drudgery. Begin by taking two sheets of paper, one labeled "Income" and the other "Expenses." You goal will be to forecast all cash sources and cash expenditures for a 12-month period.
If your business is an established one, you can use historical information on sales and costs to craft a realistic budget. If you haven't yet opened for business, you will need to do research to determine what your expenses are likely to be. You will also need to make an educated guess of the revenue you can expect to generate, based on your type of business, competitors within your marketplace and the profit margins or rates of return on investment for businesses of similar size and product/service to yours. Don't forget to factor in inflation and other marketplace variables.
Income: The income sheet should list sales revenue and other major revenue-producing categories. Keep the categories fairly broad, focusing on key items. Beside each category estimate the minimum monthly target amount for the next 12 months.
Revenue or sales forecasts are typically based on a combination of your sales history and how effective you expect your future sales efforts to be. Factor in how many products you expect to sell or the number of customers you expect to provide a service to; the price you intend to charge for your products and/or services; and how much sales will grow over time. Carefully consider your planned marketing efforts, your competitors, potential demand for your product or service and the state of the local, regional and national economy.
Expenses: These are your total fixed and variable costs. List all major costs and estimate maximum monthly expenses for each category.
In the variable expense category, you will want to include the cost of raw materials or goods for resale, if your business provides a product. If yours is a service business, your biggest variable expense is likely to be the cost of labor. Other examples of variable expenses are payroll taxes, sales commissions, overtime and travel expenses, advertising, repair and maintenance and freight/delivery expenses.
Fixed expenses would include rent, insurance, financing costs, taxes on property, depreciation of equipment, utilities, building maintenance costs, office salaries and office expenses.
Capital costs would include purchase of computer equipment or, if applicable, your store or office building.
Profit: After you have a handle on your sales revenue and your costs, you can project your profit, or return on investment. Subtracting your expense total from your sales revenue will give you an estimated net income. Your business must provide you with a profit that is large enough to make a return on the money you invested when you started your firm and to pay you a salary.
If your first budget draft projects a net profit that is not sufficient to keep your business operating, or that pays you less than you would earn if you worked elsewhere for a weekly pay check, go back and readjust your calculations. You will need to boost sales revenue projections; reduce your costs; or do a bit of both.
QUARTERLY Budgets are Next
After you've prepared a monthly budget for the first year, prepare quarterly budgets for years two and three. This will permit you to monitor your progress over the coming months to detect problems and make corrections.
MISTAKES to Avoid
Flashy financial strategies may pay off short-term, but they will not ensure long-term financial success. Avoiding some common mistakes will help you to craft a budget that will meet your present needs and future objectives.
Make it realistic. An unrealistic budget won't be worth the paper it's printed on. Don't be overly optimist regarding sales forecasts or conveniently ignore your immediate financial needs. You won't be cheating anyone but yourself. Moreover, you could harm your search for funding, as well as deprive your business of a helpful management tool.
Don't skimp on details. Include sufficient information to permit you to monitor your cash flow, production costs and working capital.
Did you remember taxes? Don't forget your likely obligations to Uncle Sam. Your budget should forecast the payment of sales taxes owed on revenues and employee withholding, as well as state and federal taxes.
Take into account seasonality. Does you business provide a service (like landscaping or snow removal) for which the demand varies by season? If so, factor that into your budget. If you're a retailer, you will want to project higher sales during traditional holiday shopping seasons.
Consult the right people. Get the right people involved from the start. Internally, staff members with financial responsibilities should definitely have a role, as well as those who head specific projects, and those accountable for devising sales targets and production costs. You will also want to seek input from your CPA when preparing your budget plan.
Consider the old and the new. Historical information on sales and costs can be helpful, but it shouldn't serve as your only guide. You must also consider what your future plans are and what your competitive environment is apt to look like. Adjust your estimates, as needed, to reflect price increases, inflation and other changing factors.
HOW to Use Your Budget
Once you've developed a budget, keep it "front and center." Review it frequently (at least quarterly, but hopefully once a month) and revise it as the need arises. Keeping your budget up-to-date provides you with helpful flexibility. And, it will show you whether or not you are making progress toward the achievement of your business plan goals.
You will want to pay close attention to your actual income and your actual expenditures. It is recommended that you compare your actual income to your sales budget or revenue targets each month. If you fell short of your budgeted goal, ask yourself why. If you exceeded your revenue target, determine what factors led to the increase in income. Compare timing factors to determine whether you are making the proper projections.
You will also want to regularly review your actual expenditures against your budgeted costs. Doing so will help you to better predict your future costs. Look at how your fixed costs differed from your budget. Were your variable costs in line with your sales volume? Analyze any reasons for deviation. Were differences due to the timing of your expenditures, unexpected costs or another factor?
If your review demonstrates that you need more revenue than you are earning, you will have to adjust your plans. Should you expand your sales? Or, perhaps you need to look for ways to cut costs. Maybe it makes more sense to lower your profit expectations.
FOR MORE INFORMATION on Budgeting for Small Businesses
The SBA Online Women's Business Center (www.onlinewbc.gov) offers information on "Budgeting in a Small Business," which includes a lesson summary and basics of budgeting. The U.S. Small Business Administration (www.sba.gov) was created specifically to assist and counsel small businesses. Its Web site offers information on budgeting for the small business.
If you're planning to establish a new business within a particular field or sector of industry, consider consulting relevant trade associations. They can provide valuable resources and research to current and prospective members of their industry. Many offer newsletters, workshops, conferences and seminars with information that would be helpful to those entering that line of business. You can locate trade associations through searches on the Web or by consulting a directory of associations at your public library.
BBBTips™ is a trademark of the Council of Better Business Bureaus, Inc. (CBBB) used for information provided to assist consumers and businesses in making informed and intelligent decisions. BBBTips™ are developed in partnership with the Better Business Bureau Consumer Education Foundation, Inc. and made possible, in part, through the generous financial and technical support provided by corporate sponsors that are members of the CBBB and of the Better Business Bureau where the sponsor is headquartered. As a matter of policy, the CBBB and Better Business Bureaus do not endorse any product, service or company.