The new year is upon us and, if you’re like most small-business owners, you’re already thinking about creating a budget for 2015. According to Michelle Edwards, CPA and CEO of Trailhead Accounting Solutions, “An annual budget helps business owners plan for the future.” Running a business isn’t easy, but your budget provides you with a financial plan that helps put you in control. In addition, she says, annual budgets can help small-business owners accomplish their goals by giving them the financial tools to keep track of all the moving pieces.
Estimate Your Expenses
The first step in creating an annual budget is to list all of your expected expenses for the upcoming year. You’ll need to list the expenses that won’t change — such as rent, salaries, and loan and insurance payments — and estimate expenses that, according to your sales figures, are likely to change — such as the cost of inventory, materials, and sales commissions. Edwards advises business owners to include everything, because even the little expenses add up. “Budget for more expenses than you expect,” she says. If you’ve been in business for a while, you can use past records to estimate next year’s expenses. But if you’re just starting up, Edwards says you should do some market research to determine the cost of your expenses, including:
- Call around to determine the current rental rates in the area where you will be located.
- Ask industry leaders for the going rate for employees in your industry.
- Call an insurance broker and get quotes on the types of insurance you’ll need.
- Contact industry suppliers and get quotes on supplies and inventory.
- Call an accountant and get a quote for accounting services.
Finally, Edwards says you should network with others in your industry. “Not everyone is willing to talk,” she says, “but you would be surprised how many people out there are willing to help their competition.” In short, Edwards says you can determine estimated costs for just about everything. But it may require some creative strategies.
Estimate Your Income
The next step is to estimate the amount of income you’ll earn. “Existing business owners have the power of historical data on their side,” Edwards says, “and history has a way of repeating itself.” Look at your previous year’s financial statements to spot patterns and trends. For instance, if your business has been steadily growing by 10 percent every year, or you see a spike in sales during the fourth quarter of every year, you can use those patterns and trends to help you estimate your future income.
Just remember to be conservative in your estimates. “The biggest mistake I see is that entrepreneurs are typically very confident and see bright futures ahead,” Edwards says. She always asks her clients if they are 95 percent sure their income scenario will happen. If not, she advises them to bring their estimated income numbers down because it’s better to plan for lower numbers and be pleasantly surprised when you exceed expectations.
On the other hand, for startups or new businesses, Edwards says you have to do research and create forecasts. You can get an overview of your industry’s financial statistics by using BizStats‘ free research tools, then estimate your income by creating a sales forecast using this instructional three-part video series provided by the Small Business Administration.
When the Numbers Don’t Line Up
Sometimes, no matter how much care you put in to creating a budget, the unexpected happens and the estimated expenses and income don’t line up with the actual numbers. Edwards says when this happens, it’s important to find out why. For instance, if you budgeted $120,000 in sales but only generated $85,000, you’ll need to look at each line item to figure out what happened. Maybe you had fewer clients than you expected, some clients had smaller bills than normal, or a particular item stopped selling. At the same time, if your expenses were higher than you expected, you also need to find out the root cause.
Then, Edwards says, you should determine whether you can expect the same results in future months, or if you can create a bigger demand for your product or cut expenses. “Your budget should be a living document,” she says. “Visit it monthly and compare your actual results against your projected results, then use the knowledge to update your budget and reflect the changes going forward.”