When starting a business, many owners underestimate the expense of performing daily procedures, from labor costs to ordering the necessary supplies. If resources are not planned appropriately, this can create financial distress in the future.
By creating a startup budget, companies can prevent financial missteps, practice cost reduction strategies, and maintain profits.
Who Needs a Startup Budget?
A startup budget outlines how a business plans to invest its funds to cover financial obligations and preserve profits. Therefore, every business owner looking to start an organization with bills and income sources needs a startup budget.
Startups need to plan out their budget before their launch to determine revenue and sales targets. Otherwise, the business will not know how much income to generate to cover monthly expenses.
Since startups do not have historical information to formulate budget projections, business owners must conduct market research to make educated forecasts. Once the startup begins generating income and organic leads, management can collect data to develop insights. By analyzing sales data, startups can determine how to optimize resource usage and fund allocation to reduce costs and promote profitability.
Creating a startup budget doesn't just enable companies to avoid financial blunders, it promotes data-based decision-making. By investing the time and resources into developing a detailed startup budget, businesses can-
- Determine when/how many employees to hire.
- Determine what equipment and assets are needed.
- Determine how to scale the company without relying heavily on credit.
- Calculate the break-even point.
- Predict cash flow inefficiencies.
- Negotiate supplier agreements.
- Define sources of income.
- Generate financial reports, such as balance sheets and expense reports.
The more detailed the budget is, the more prepared the startup is to face unexpected events and capitalize on emerging market trends.
4 Steps for Creating a Startup Budget
While budgets consist of several elements, startups can simplify the process by breaking it down into four comprehensive stages-
1. Create a Detailed Plan
First, business owners must plan out their day one, or the essential elements to manage for the grand opening. The day one plan can be separated into four sub-categories-
Facility costs, also referred to as leasehold or tenant improvements, include every expense required to rent a store, warehouse, or office. Startups planning to use remote workers do not have facility costs, as employees work from home. However, owners should plan ahead in case they would like a corporate office to house executives.
It is also essential to factor in lease deposits, renter's insurance, and storefront signage if applicable.
Fixed assets, also known as capital expenditures, are costs related to acquiring assets, such as equipment, property, and computers. Typically, any one-time investment needed to start a business is a fixed asset.
Materials and supplies are items that need constant replenishment, such as office supplies, advertising, and promotional resources.
Some startups have other costs, such as permit fees, furniture, and legal expenses. Regardless of whether the expense is a monthly bill or a one-time payment, business owners need to note the cost in the startup budget.
2. Estimate Monthly Expenses
Businesses typically handle fixed and variable expenses. Fixed expenses are costs that do not change over time and are not dependent on business performance. For example, the rent for a building will not increase based on customer traffic. Other common fixed expenses include-
- Publication subscriptions
On the other hand, variable costs are expenses that fluctuate depending on a company's patrons. Typical variable costs include-
- Postage, packing, and shipping costs
Startups need to list their fixed and variable expenses to gauge where most of their financial obligations lie.
3. Project Monthly Sales
Since estimating monthly sales can be challenging, owners should generate three different projections-
- The best-case scenario will be a generous estimate for first-year sales.
- The worst-case scenario is the least optimistic case, with the minimum sales for the first year.
- The likely scenario falls in between the best and worst scenarios and is typically what is presented to lenders.
To prepare for the worst outcome, startups should assume that not all of their sales will be collected. Depending on the customers' preferred method of payment, the business may have various collection percentages. The collection percentages should be calculated with each month's estimated sales.
4. Create a Cash Flow Statement
Lastly, owners must create a cash flow statement to illustrate the amount of money entering and leaving the company each month. This report helps stakeholders and lenders see a company's financial health and stability.
To start the cash flow statement, owners must combine their total costs and money collections from monthly sales. For some businesses, sales and collections may be the same, while others may have different lines of income, depending on the type of payments they accept.
For example, a cash flow statement may look like-
Monthly sales- $35,000
Total fixed costs- $15,000
Total variable costs- $9,000
Total cash balance- $7,000
The total cash balance refers to the amount of cash the business has on hand at the end of the month, not the profit.
By changing the sales and expense variables, owners can create the three scenarios and generate a monthly income target. This gives startups a better idea of what is needed to fulfill their financial obligations.