If you’re like many self-employed professionals and entrepreneurs, you’re working around the clock to get your business off the ground. But before you get too far along in your plans, consider taking advantage of some small business advice: Set yourself up for success with a small business budget.
Benefits of Budgets for Small Businesses
You reap numerous benefits when you draw up a small business budget.
Wise budgeting enables you to:
- Allocate the right amount of resources and manage your finances effectively
- Monitor how your business is performing
- Accomplish your objectives
Building a budget for your small business also makes it possible for you to:
- Improve your decision-making process and make plans for the future
- Identify potential financial problems
- Motivate employees more effectively
At its core, your budget reflects your business priorities. Once you build it, your budget shows you how much you have, what you expect to earn, and how you intend to spend it. Budgets for small businesses give you and other owners like you a clearer understanding in real time of the financial landscape for your business and issues that need addressing. Armed with this information, you develop more wisdom and confidence to make decisions that benefit your enterprise.
What’s a Good Way to Start the Budgeting Process?
Say you’re in the business of making and selling hand-loomed sweaters. You know that you need a budget, but don’t know where to begin. Gathering this information is a good way of starting:
- Your sales projections for the budget period
- Your direct costs involved in your sales
- Your fixed and variable overhead and non-overhead costs
It’s important to be realistic when budgeting. This is because your budget projects your month-to-month cash position. Knowing your cash flow situation is crucial to being informed about the condition of your business. Overestimating your sales or underestimating your direct costs for items such as materials, suppliers, or subcontractors can throw your budget out of alignment and cause cash flow problems. Keep in mind that underestimating your sales and overestimating your costs can create a cushion in your small business budget that helps you through times when money is tight. Your sales and expenditure forecasts form the basis for preparing profit forecasts for your 12-month budget cycle. You can derive profit margins and return on investment (ROI) figures from this information.
Making Sales Projections for Your Budget
When starting out, you may not have accurate figures for sales projections and other sources of income you want to include in your budget. Don’t worry. Just make your best estimate, and as your business moves forward, you can make more accurate sales projections based on your experience. Information on past sales can be helpful as a guide. But if your circumstances are substantially different, you can’t count on the accuracy of past figures for your current budget.
Say you knit and sold your sweaters independently as a hobby last year and sold 24 sweaters in 12 months. Now you’re producing them full time, devoting 60 hours or more per week to your enterprise instead of only 20 when it was a hobby. You have an assistant, a current inventory of 75 sweaters, and a marketing plan to boost sales. Under the circumstances, you may project at least three times as many sweater sales over the same 12-month period. Going though a complete annual budget cycle positions you to make more accurate forecasts.
Calculating Costs for Your Small Business Budget
A small business budget usually includes three types of costs: fixed, variable, and one-off capital costs. Rent, loan interest, and salaries are in the fixed cost category, and variable costs include raw materials and overtime pay. Capital costs include items such as purchasing an office condo and computer equipment. Looking at past bills from suppliers and last year’s records can help you estimate your costs.
To calculate the costs for your artisan sweater business, say your fixed costs include rent for your sales kiosk at the mall, liability and disability insurance, and your assistant’s salary. Your variable costs include your utility bills at your workshop, marketing costs, and fuel and maintenance costs for your work van. Capital costs include your computer, workshop furniture, and production equipment, such as your dye vats and dryer. For an accurate budget, you should include numerous other costs under these categories.
Why Small Business Advice Includes Regular Budget Updating
As a new business owner, you get the maximum benefit from your budget if you review and update it continually. Among the benefits of an updated budget is the ability to manage your cash flow and set goals for your next budgeting period.
Wise business practice also includes using sales information from your small business budget to:
- Compare your income projections to your actual income
- Examine reasons for shortfalls, such as lower sales volumes or products that don’t sell as well as expected
- Determine reasons for exceptionally high sales volume, such as setting sales projections too low, or the occurrence of an event that caused a sales spike
With this valuable data, you can create more accurate budgets and make necessary changes. Imagine that while examining your budget, you notice that the first two weeks of March reflected a winter sweater sales volume twice as high as your projection for the entire month. When you investigate further, you find that your end-of-season sale coincided with predictions by meteorologists that your geographic region expected to experience a cooler-than-normal spring season. The combination of events may have caused the sales jump.
In addition to reviewing sales data, comparing your budgeted expenditures to your actual spending enables you to make more accurate cost forecasts. Your fixed costs should match your budget projections. If they don’t, you should investigate the reasons why. Examining your budget cost information regularly gives you valuable insight into the answers to these questions:
Do your variable costs align with your sales volume?
If the relationship between your costs and turnover changed, do you know why?
* If your pattern of making expenditures changed, can you explain the reason for the shift?
Say your budget shows your variable shipping costs increased by 25% in March. This is consistent with the increased sales volume you experienced in March. And if your budget shows you spent 20% more on Donegal wool yarn in April than you budgeted for, you want to know the reason. Perhaps your supplier increased the price, or switched from net 30 invoicing payment terms to net 15.
Evaluating Your Business Performance
With all the hard work you put in year after year, you want to see how your business is growing. Reviewing your annual budgets are a great way to make performance comparisons over months, quarters, or years. Your information from years past lets you examine your profit margins to assess how well you’ve done.
In addition, you can compare your growth with that of competitors in your industry, or compare results of one part of your business to another. Sales, costs, and working capital are three key performance indicators (KPI) that most businesses use for comparison purposes, so you can focus on results in these areas as strong indicators of growth and development.
When you build them accurately and use them wisely, budgets for small business are effective tools that help you achieve your short- and long-term goals.
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