When you create a budget, you’re creating a plan of how to spend your money. Creating this spending plan lets you determine, in advance, if you have enough money to do the things you need or want to do.
Budgets are important. Yet very few people actually enjoy creating them. Developing and managing budgets can be a pain. Without them, however, you don’t really know how your business is doing, nor are you able to optimally plan for the future. If you are budgeting by memory rather than using software, or worrying about payroll from week to week, you may actually be putting your company in danger.
Budgets are a living, breathing part of a successful business. If you plan them precisely and revisit them frequently, they can help increase your confidence. It’s best to use them as a map for the future, as well as a financial journal that describes where you have been.
There are three essential components of any budget:
- Sales and other revenues
- Total costs and expenses
Here’s a look at each in more detail.
1. Sales and Other Revenues
The more accurate you are with your revenue estimates, the easier next year’s finances will be. Be conservative as you check over last year’s revenue; evaluate the current economy and the situation of your business.
If you’re a startup, look at the financial health and growth of others in your industry. Use your experience, and conduct market research. If you’re an established business, use the prior year as a base but adjust for current projections and marketplace conditions.
2. Total Costs and Expenses
Next, calculate your total costs of doing business. That includes identifying fixed, variable, and semi-variable expenses.
Fixed: This includes costs such as rent, leased items like electronics, heavy equipment, furniture, and insurance.
Variable Costs: These expenses change based on sales. These include raw materials for manufacturing, freight costs and inventory.
Semi-variable: Salaries, advertising, and telecommunications are typical examples.
This is why you are in business. Use either of these two formulas to determine if you made a profit:
Sales = total cost + profit
Sales - total cost = profit
If you are a startup, benchmark your profit levels against others in your industry by checking with peers in your field and conducting market research.
Without a good handle on what your profits will be from year to year, it will be next to impossible to plan for future years. New equipment purchases, a move to a larger location, and the raises and bonuses due your employees will all be dependent on understanding the profit position of your company.
The goal of identifying a budget outline is twofold: it helps you to find and organize information. A framework that is appropriate for your business will enable you to develop a budget with precise costs and income. Use the same outline from year to year to understand your prior years and help you plan for the next ones.
Incorporate these tips when preparing the budget outline for your business:
- Check trade journals and associations to find current industry standards and estimates. The internet and the library are great places to start.
- Utilize a budget spreadsheet that will help you figure out how much you need to allocate for raw materials, rent, taxes, insurance and other expenses.
- Consult with your suppliers if you work in a volatile market.
- Plan it out, month by month, for the calendar year. In addition, include a longer-range version on a quarter-by-quarter basis. This will be helpful for financial statement reporting.
- Check your budget over and look for areas where you can cut expenses. Look for new suppliers with lower costs. Ask your insurance agent how you can lower your premiums. When you see all the numbers in front of you, in the context of the overall budget, some expenses will stand out as too high. This is the time to look for better deals.
Budgeting Basics and Best Practices
There are a number of budgeting best practices you should follow:
- At the very latest, put your budget together during the last two months of the year. This allows enough time for research, double checking figures, and discussion. If you prepare your budget too early, your numbers might not be accurate enough. If you do it too late, you won’t have time to make needed adjustments.
- Update your budget each month with the help of managers and your accountant. Factor in how well you did for the month and what your expenses were. Look at probable sales for the coming month. Be sure to take note of any upcoming expenses that you did not anticipate.
- Make changes like altering your staffing schedule to match market conditions. Try different actions that can help your bottom line. Perhaps you can speed up payments from clients as a way to improve cash flow.
- Link performance bonuses for your staff directly to the budget. This gives each eligible person a reason to keep the needs of the business front and center when making decisions during the month.
- Adjust the budget and account for changes you hadn’t anticipated. If a significant client cuts back on his orders or if a supplier suddenly has a slowdown in deliveries, you need to act quickly to keep your budget in equilibrium. Your budget isn’t static, just like your business.
- Always check your budget before making a significant expenditure. One of the most helpful aspects of an up-to-date budget is reducing risk. It will tell you if you can afford to buy a new piece of machinery or sign a lease.
- Every company needs to spend time developing and updating their budget throughout the year. Your investors and lenders will want to review it if you are looking for an infusion of capital. Your budget helps you to manage cash flow and keep up with payments to employees, vendors, and suppliers. Most importantly, it can help you plan — and realize — future growth and profits.
Have questions about your cash flow? Talk with the Cash Management experts at Liberty Bank.