Creating a Small Business Budget - A 6-Step Guide
Creating a small business budget based on data, such as seasonal trends and profit and loss statements will allow businesses to anticipate financial demands in the future.
Using this information, companies can have a clear plan to move forward and be responsive to any fluctuations in economic and consumer conditions. A small business budget aims to reduce expenses and increase cash flow for an optimized bottom line.
What is a Small Business Budget?
A small business budget is essentially an overview of a small business's finances. This outlines key details about the current state of the business's finances, such as expenses and income, as well as the long-term financial goals of the company.
Budgeting allows for educated reasoning and sound decision-making about business processes, such as staff scheduling and inventory ordering, with the primary objective of minimizing cost and maximizing profit.
Understanding the key financial data from the past and assessing the current state of the cash flow will play into how a budget can help small business owners plan for short and long-term success. The main benefits of creating a small business budget include-
- Having a road-map to make decisions about finances and have more confidence in those decisions.
- Understand what needs to change to reach the financial goals of the business.
- Identify the key places to cut spending to grow revenue.
- Successfully land funding when applying for small business loans or reaching out to investors.
- Predicting slow months and responding to cut expenses.
- Identifying surplus funds to reinvest for growth.
6 Key Steps to Create A Business Budget
The following steps guide the creation of a small business budget. Depending on how long the company has been in business, the steps may differ slightly.
For example, the longer a business has been operating, the more data there will be from past operations and sales to create a future budget plan. A new business will be required to research this data to determine the common costs within the industry or business type to estimate forecasted cash flow.
#1- Assess Revenue
The first step is to identify all of the income sources. Add these sources together to learn about the cash flow that comes into the business for a set period, such as on a monthly basis. It's important in this step to calculate the revenue, not the profit. This is the amount that comes into the business before the expenses are subtracted. The profit, on the other hand, is the amount remaining after the expenses have been subtracted.
After the income has been calculated, it's important to do this for a longer period. If it was calculated for a month, then do this for multiple months, for at least 12 months, if the data is available. With this information, it's then possible for a business owner to assess the monthly income changes to determine if there are seasonal patterns, like post-holiday slumps. This information can then determine future decisions to prepare for seasonal shifts.
#2- Add and Subtract Fix Costs
Secondly, all of the fixed costs should be added together. The fixed costs are any expenditures that are recurring for the business to operate. They could be recurring daily, weekly, monthly, or annually. Examples of common fixed costs include lease expenses, supplies, payroll, tax, debt repayments, asset depreciation, and insurance.
Every business is unique, so it's important to examine what fixed costs are individual to the company, beyond these typical expenditures. After the costs have been added, this figure is then subtracted from the income.
#3- Examine Variable Expenses
Additional to fixed costs are variable expenses. These are costs that change depending on demand (either internal demand from operations, or consumer demand). Utilities is a good example of a variable cost, as although it is recurring, it is different for each pay-cycle.
Some costs may be found that aren't essential for daily business operations. These costs are known as discretionary expenses', and can be added to the variable expense amount as well. Examples of variable expenses include office supplies, marketing costs, professional education and development, old equipment replacements, and the owner's salary.
During months where there is less incoming cash flow, the company should limit variable expenses as much as possible, with the discretionary spending being the first to be cut. During profitable months, businesses can heighten variable spending with the goal to grow the organization in the long term.
#4- Contingency Fund Set Up
This fund is essential for managing unexpected costs. To prevent anxiety and financial instability, it's important to ensure there is extra cash-on-hand to pay for unexpected costs such as appliance repairs.
Though it can be tempting to spend income surplus on more variable expenses, it's crucial to put aside some of this for an emergency fund, so that things like damaged inventory or broken equipment can be dealt with as soon as possible without putting a strain on the business budget.
#5- Profit and Loss Statement
All of the above information is then compiled into the profit and loss statement (P&L). This is a basic addition and subtraction formula - all of the income for the month is added and all of the expenses are subtracted from the income. The final goal is to have a positive end number, which conveys that the business is profitable.
If the business has taken a loss, management should know that many small businesses, especially in the beginning, will experience similar financial situations.
#6- Create Future Business Budgets
Projecting what is going to happen in the future usually involves some level of guesswork, but businesses can utilize historical financial data to ensure all decisions are educated. With the P&L created, the budget can be made. Referencing the P&L gives an idea of the seasonal swings of the business, which investments were advantageous, and what costs can be avoided to bring in more cash flow.
The following trends are going to be beneficial to identify in the P&L-
- Supply and equipment purchasing that created losses.
- Sales trends in relation to weather, economic issues, supply problems, or natural disasters.
- Seasonal trends aligning with school calendars or tourism.
- Profit increases without a clear explanation.
Examining the P&L is about understanding what created the fluctuations in cash flow, so these can be replicated or avoided as the budget is being created.
Ultimately, creating a budget can provide small businesses with the right strategies for spending and provide the necessary information to make important financial decisions. This is all undertaken with the overarching goal of becoming more financially stable and profitable in the long-term.
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