Managing expenses is important for any company, but for small businesses, improperly managed budgets can force you to close your doors. While your idea may be unique and fit perfectly in your corner of the marketplace, paying too much for employees, supplies or rent can quickly eat up your profits. Most small business owners wear many hats, but the successful ones are experts in budgeting to maximize profit margins.
It's essential for your small business to establish and maintain an effective budget that helps increase profit. An understanding of these basics is a great place to get started.
Importance of Developing a Business Budget
A business budget differs from a personal budget, although they share many similar components. Month-to-month planning for a seasonal or cyclical small business, such as a tax preparation specialist or a lawn care company, can be essential to help keep you afloat when times are lean. Moreover, watching your small business expenses can help you see patterns of months that business is booming and months where you know you have to plan ahead to cut expenses or dip into a reserve fund.
Developing an ongoing business budget is different from your initial start-up budget. While you may have certain costs that come up once a year or once a quarter, your monthly operating budget is focused on recurring costs and incoming revenue. Creating a business budget allows you to track expenses and put money where you think it should go. You can forecast revenue based on your history and plan larger expenses such as equipment or an advertising campaign.
Plus, from a trust standpoint, an effective budget better allows your small business to uphold its commitments. BBB Accredited Businesses are charged with honoring promises in the marketplace, and those include contracts made with suppliers, landlords, and employees. Fulfilling those commitments is more difficult when expenses are properly being looked after.
Components of a Business Budget
Business budgets have several main components. There are some online tools that can help with the "nuts and bolts" of budgetary planning; simply input the numbers for your business in pre-built templates to get going. Remember, save copies of invoices and receipts as a budget backup and for possible tax filing or IRS disputes.
Estimated Revenue: This is what you plan to take in from sales each month. If you're a new business and aren’t sure what your initial revenue will be, use industry averages. For those who have been in business for over a year, look at actual numbers from the past year. As you record these data points, make notes about where you got certain figures. For example, if you own a café, then maybe you got extra business due to a convention coming to town that met at a nearby conference center.
Estimated revenue can be fluid and revised up or down each month depending on what you actually take in. It might be a valuable tool to have a side-by-side comparison of actual revenue and expenses with your budget. Having this snapshot can help you determine where to cut expenses and how to tighten up your budget to pursue short- and long-term financial goals.
Fixed Costs: These are costs that remain the same each month. Your rent, your personal salary (you should be paying yourself!), insurance premiums, and equipment leasing are all examples of fixed costs – things that cost the same whether you sell one item or a thousand.
Having a handle on your fixed costs provides a benchmark for your break-even point. Knowing how much you have to sell or how many clients you need to cover fixed expenses is essential to making smart business decisions, especially while setting the pricing for goods or services. Although you'll want to do a market analysis of what your competition is charging so as not to over or under price yourself, knowing what you need to make fosters informed decisions.
Variable Costs: These costs vary depending on your volume of business. Employee wages, supplies for goods you produce and extra sales commissions or travel fees are all things that vary month to month. It's important to note that hourly employee wages typically fall under this category – a higher volume of business will need more people to serve your clients. Salaries, on the other hand, are generally fixed costs, as they don't vary month to month. These are also referred to as controllable costs.
"Cutting costs" generally refers to cutting variable costs. For instance, you may not be able to cut your rent during the lean months, but you can reduce hourly payroll expenses, advertising costs or extra things like client lunches. Office supplies and some utilities are also variable costs and can be trimmed during leaner months. It's important to look over each invoice – you may be able to shop around to different vendors or purchase in bulk to receive a discount. Bulk purchases of non-perishable items, such as paper and shipping boxes may be something that you plan for your busiest months, cutting these recurring expenses during leaner times.
Irregular costs: These costs are may not be fixed every month, such as professional memberships, equipment upgrades or new office furniture. Some service industries require you to maintain a license or take a certain number of training hours each year. Part of your budget should include when to renew a professional certificate or take these courses. If you need to take time away from your business to complete these, then you'll need to budget to pay for extra employee coverage.
Some industries also have professional organizations that, while vital to networking, also may have steep dues. Consider paying your dues in a lump sum if you have an especially busy month, or see if you can break it into a monthly cost that's more manageable with your cash flow.
Cash Flow: This term refers to the money coming in and out of your business. Positive cash flow means you have more money coming in than going out. Negative cash flow is the opposite. Your budget should be able to give you a snapshot of your cash flow at any given point, assuming you're entering your expenses and revenue in a timely and accurate manner.
Understanding your cash flow allows for planning, investing and taking care of unplanned expenses. In addition, you can use your cash flow to plan purchases and determine your billing cycle. We have featured pieces on how to manage your cash flow and some basic cash flow rules that you should take time to review.
Profit: This is what money is left after paying expenses. You may choose to save profits for a rainy day, reinvest it in the business or keep it for yourself. If your small business profit margins aren't where you anticipated, it may be time to cut costs, raise prices or drive more business with a larger advertising budget.
Short-Term Financial Planning
A business budget should be flexible. Some months, certain line items are higher — like the times you may have to make a balloon payment for insurance or pay dues to professional organizations and licensing. If you can, factor these expenses during months where you forecast more revenue, eliminating the need to dip into reserves or make a lean month even leaner.
Short-term financial planning is especially important for businesses in their first year or two and still gaining momentum. You'll use your cash flow snapshots to help make expense decisions for the following month, such as hiring a new employee or reducing hours, launching a new product line (and the start-up costs that go with it), or investing in new equipment or a different physical location.
Your short-term planning should also include plans for the positive cash flow of your business. Will you keep some in a business account, choose to invest profits in an investment bearing account, or apply extra cash to future expenses? Making smart decisions with your positive cash flow can help your business during lean times.
Long-Term Financial Goals
Your long-term financial goals may dovetail with short-term goals – increasing profits, reinvesting in the business and enjoying the profits from hard work are all extremely good goals. However, long-term planning may be the difference between a struggling, stagnant business and the thriving, established business that you envisioned. This can mean a location in the most desirable area, a business that's sustainable enough to fund your retirement, or diversifying into other markets, product lines or services.
Determining your ultimate long-term goals is a good first start to long-term budgeting. You may choose to set aside some profits each month toward these goals – either saving for new equipment or investing your money for passive income. Determining the costs for long-term goals will help you realize how to manage your budget now to reach your objective.
Creating your long-term budget and financial goals can be very similar to the start-up budget you prepared. You may even choose to create a business plan that lines out benchmark goals for financial success, reputation in the community, and your own personal expertise within the business. For example, a salon owner may choose to get certified for pedicures, facial waxing or advanced coloring techniques. Each of these professional improvements will cost time and money, not just for the training, but possibly in terms of extra employees to help run your business while you're in class or studying.
Making Your Business Budget Work For You
Your business budget works when you enter the right numbers and make the right decisions. Use it to track your expenses and see where you're spending too much. Use it as a tool for long-term investment or as concrete data when approaching approach banks for loans. For cyclical businesses, creating an analytics program that shows the ebb and flow of cash can help show business cycles and plan everything from vacations to new machinery.
Creating a budget for your small business is not only necessary but can be used as a tool to reach long-term goals, retire successfully, diversify and reinvest to grow your labor of love. Accurate budgeting can also give you a picture of where your cash is going, making sure that you aren't overspending in unexpected areas, or giving you the freedom to increase some line items like advertising and marketing.
Having a solid budget also puts you in a better position for approaching banks for a small business loan. Banks like to know that they're investing well and that they'll see their loan repaid. When you can demonstrate that you have a handle on your cash flow, you'll be a more appealing investment to lenders.
Budgeting can increase your profits both by cutting unnecessary expenses and showing you where to reinvest and grow. For a start-up or seasonal business, it can also help keep you afloat during leaner times. For every business, it's important to watch your pennies so that the dollars take care of themselves.