A budget is a powerful tool to monitor the operation of your business.
A budget makes it easy to control your spending and achieve your profit goals through financial planning. In business, a budget is your roadmap for future income and expenses. Many small businesses use budgets as a goal-setting tool. They determine how much profit they want and then list out their expenses to find out if their profit goal is possible. And if not, then they can use their budget to find ways to achieve their profit goals.
Budgets are always changing. Your business grows quickly and suddenly you need more employees or cars break down and need costly repairs. Life happens and there are shortages and pitfalls. If you understand that budgets are dynamic, ever-changing plans and commit to regular updates and reviews, then you will have a firm command of the financial success of your company.
Starting a business budget may be confusing, but not having a budget can lead to disorganization, cash flow problems and potential failure. You need to assess your financial situation both now and in the near and distant future. In a 2016 study by Wasp Barcode Technology, over a thousand small business owners surveyed were asked to define their biggest challenges in running a business, which resulted in the following:
According to a U.S. Bank study, 82 percent of small businesses fail because of mismanaged cash flow. You need cash to run your business, pay your vendors, pay for supplies and make your tax payments. Cash flow problems mean that you have bills to bay and no cash to pay them. A budget is a powerful tool for watching your incoming and outgoing money, tracking where overspending is occurring and planning for times of shortages. Personal budgeting is also beneficial for new business owners funding their venture.
There are many tools available for starting a budget. Your bank, your accountant, even your bookkeeping software may have a worksheet or program for you to use. You can also use a simple spreadsheet program or paper and pen. There may also be free financial planning tools available online. Look at the different options available and determine what you think will work best for you. It is crucial that you are comfortable with your budget so that you will use it and refer to it regularly as you manage your new business.
To know how much you will need to save for a business, you will have to consider the two main parts to your business budget: projected revenue and expenses. The expenses describe the outgoing money. There are also fixed expenses and variable expenses. Fixed expenses are your monthly payments, and they are the same amount every month. Items that fall under fixed expenses are rent, equipment rental payments, insurance, credit payments, tax estimate payments and payroll. Variable expenses are monthly expenses that vary each month. Utilities like gas, for instance, are higher in the winter. Other items that would fall under variable expenses include the following:
As you gather information about all of the business expenses be as complete and detailed as possible. The $36 per month for parking may not break the bank, but more than one of these small expenses will skew your budget and leave you wondering where the money went. You may need a business loan to cover your expenses until earnings come just to stay afloat.
For a new business, the projected yearly revenue is trickier to define than it is for an established company. Generally, this number is based on the previous year’s sales. But it is important to calculate this number to know what you have to do to meet your profit goals and be successful. To calculate this dollar amount you will have to do a little bit of research.
How much are buyers spending on your type of business or service?
Refer to the Bureau of Labor Statistics and look up your type of business. Research your industry to see what you can expect from sales based on how other companies did in recent months or years. You will get real information about how much consumers are spending for your kind of products and services, such as:
How are sales numbers calculated for your type of business?
Sales are calculated differently for different industries. For example, a lawn care service business will calculate sales by billable hours, while a retail store calculates sales per square foot.
How many potential customers do you have?
Identify your customer demographic. For example, if you are opening a barbershop, then your customer is a man between 17 to 65 years of age. Next, use government census data to get an idea of how many of these customers live within a five-mile radius of your shop. Be realistic. Will a 30-year-old man travel more than five miles for a haircut? Maybe five miles is too far.
What is your market share?
If there are other businesses like yours – offering the same service to the same demographic of people – you will all be “sharing” or competing for the same group of customers. Determine how many businesses there are in your area, and then divide the total number of potential customers by the number of businesses.
How much will a customer spend?
Lastly, consider how often a customer will buy from you and how much that customer will spend. Using the barbershop example, a customer will visit the shop every four weeks and pay $20 on a haircut.
Putting It Together
Use the results from your research above and use this formula for calculating your projected yearly income:
Number of market share customers X average sale X number of annual purchases
If the barbershop’s number of market share customers is 200, then the formula would look like this:
200 x $20 X 12 = $48,000
Plug your projected annual revenue into your budget and subtract your expenses. How does it look? Are you meeting your profit goals? If not, then look for ways to cut costs or increase revenue. Maybe adding product sales to your barbershop can increase revenue. Add another barber who will pay a monthly booth rental to help you cover costs. Or go back to your vendors and negotiate better pricing for your products.
It is easy to understand how important a budget is for guiding and controlling your new small business. But a budget is just a worthless piece of paper if you do not use it. Update your budget monthly, including adding all your actual sales and expense numbers. And make adjustments that will grow revenues, increase profits or decrease spending.