When it comes to business financials, most entrepreneurs would rather focus on building their business than looking at pages of numbers. The truth be told, it’s not essentially for a small business to have a budget. Hey, how many people do you know who don’t balance their bank accounts?
However, the reality is that every small business owner can benefit from preparing an annual budget. Firstly, there may come a day when you need to apply for a bank loan, buy a new piece of machinery or expand your locations. It’s good to have a budget in place now than to have to pull one together when one of these events occurs. Secondly, a budget isn’t about predicting your future but instead crafting it. When you put your goals to paper a funny thing often happens; you achieve them!
What Is A Budget?
Simply put, a budget is a financial road map for your organizations performance. While the process can be quite complicated large organizations, smaller companies tend to focus on two basic budgets: operations and cash. While the budgets focus on two slightly different things, they will both typically cover a one year time frame.
Operating Budget
How much revenue will you generate next year? How much will you spend on marketing? Will you make a profit during the Summer months? These are questions that are usually answered once the operating budget is complete. The goal of this budget is to provide the blueprint for how the business is going to operate in the coming year. As a result, it typically relies on information from functional areas such as sales, marketing, distribution and customer service. At the end of the process one should have an income statement that shows how much profit the business expects to make at the end of the year.
Cash Budget
Unlike the operating budget, the cash budget is a little more of a financial exercise as its purpose is strictly financial. What we mean by that is that it’s designed to ensure that the business has enough cash to fund its activities throughout the year. Emerging and growing companies often find themselves strapped for cash even though sales are increasing and they are profitable. The goal of the cash budget is to ensure that you don’t run out of cash, especially at an inopportune time (like when you need to load up inventories for the next quarter).
How To Budget
Budgeting doesn’t have to require a trip to your accountant or the use of fancy software. With a little time, commitment and thought any small business owner can prepare a useful budget. As the operating budget is probably the most used and easily understood of the two budgets, here are 6 tips on how to go about preparing it:
1) Review prior period data.
If you’ve been in business for a while, take a look back at your past performance. If possible, review your results for the past two or three years. Unless you are starting a new business or developing a new product, this will be the best indication of what’s going to happen in the next year.
2) Develop reasonable assumptions.
After reviewing the data, develop some assumptions about the future. What will sales growth be? Is the market for your products or services expanding? How effective will your marketing program be? What will your competitors do? Most business owners have strong sense of intuition about these things so listen to it and then incorporate it into your plan.
3) Determine expected revenues.
Use your historical data and assumptions to make sales projections. Some companies establish a target that is realistic and attainable while others prefer a “stretch” budget that will be difficult, but not impossible, to achieve. Expected revenues should include not only the number of products you expect to sell, but also at what price you will sell. If you plan to increase the price, do you expect customers to continue to buy at the higher price, or will sales decrease by some degree?
4) Calculate the expected cost of goods sold.
When calculating the cost of goods sold, be sure to include all direct and indirect costs: material, labor, packaging, storage, etc.
5) Calculate expected operating expenses.
This includes fixed costs such as rent, salaries, utilities, office supplies, etc. Your bank and credit card statements will have most of these items in it, which should make your job easier. Just don’t forget to include things like price escalations and increases (e.g. rent, property taxes, etc) otherwise you’ll make your profit look better than it really will be.
6) Calculate expected operating income.
Subtract your expenses from your revenue and presto, there’s your operating budget!
Once your budget is complete, take some time to look it over and see if everything appears reasonable. If it doesn’t look right, go back and make adjustments where necessary. Periodically throughout the year you should revisit your numbers to see if you are on track to hit them. In bigger companies they revise their number periodically via a forecast. This isn’t necessary for the small business owner, but if you feel that things need adjusting to hit your target, feel free to take the appropriate corrective action. Remember, your budget is just a guideline for your financial operations, not a set of concrete numbers that have to be adhered to.
