So, your sales are rising, you paid off an SBA loan, and you just hired your first employee. Everything’s going swimmingly with your small business. Or so it seems anyway. How can you tell for sure?
One way to gauge your success is to craft a budget that acts both as guardrails and yardsticks for your business. A budget can keep your business between the lines and headed in the right direction. It can also be used to measure several key profitability metrics, giving you the data you need to optimize your success. Here’s how to create and analyze a small business budget.
What Is a Budget?
At its most basic, a budget is dollars in and dollars out. It’s a record of how much you believe you’ll make and how much you believe you’ll spend. It’s an estimate, sure. But it’s a realistic picture of your income and expenditures for the year or for some other time period, like monthly or quarterly. An annual budget is often broken out by month.
Most businesses operate on a calendar year that ends on December 31. So, in practice, you would want to prepare your annual budget for the coming year between September and December. Businesses operating on a fiscal year, which typically close out their books on a quarter-end other than year-end, finalize their annual budgets in the last quarter of their fiscal year.
What Are the Elements of a Budget?
A budget has a number of important elements under the general categories of income and expenses.
- Revenue – List out the money you expect to make from the sale of goods and services in the time period the budget covers
- Other Income Sources – Include any interest income or dividends from investments, rental income, gifts, or equipment liquidation
- Fixed Expenses – List out all your fixed costs such as rent, car or equipment leasing, insurance, utilities, or bank fees; employee salaries and benefits are usually included here as well
- Variable Expenses – Include any expenses related to the production or purchase of the product or services your business offers, including raw materials, productions costs, packaging, and shipping; marketing and travel expenses are usually included here as well
- One-time Expenses – Any non-recurring expenses you expect to encounter throughout the year can be classified here; these expenses might include computers, office equipment, software licenses, or real estate
Additionally, your budget should track any cash used in investing or any cash put into or taken out of your business from sources of financing.
Why Is Creating a Budget Important?
Budgets are important because they provide guidance for how much you’re able to spend on growing your business throughout the year. A budget can also offer you a snapshot of the health of your business, especially at month-end or year-end when you can compare your budgeted income and expenses with your actual ones. Ideally, of course, you would want to see a positive cash flow that indicates your businesses is making money and generating success.
At the end of the year, when you subtract your actual expenses from your actual income, if you don’t realize the kind of profit you forecast in your budget, then you’ll likely want to make some adjustments. This could include cutting costs, paying down debt, or initiating other budget tightening measures. Or it might mean that it’s time for you to raise the prices of your goods or services.
How Do I Determine Cash Flow?
Cash flow is the actual money going into and coming out of your business in any given time period. It can be influenced by having too many accounts receivable (unpaid invoices) on your balance sheet, which can create a cash flow bottleneck and constrain available money you need for spending. It’s important to keep accurate books that record your cash flow and then to compare your cash flow against your budget at least monthly.
What Makes For a Good Budget?
A good budget should capture all the sources of income and expenses your business realizes and categorize them accordingly. It should also help to generate usable data that you can then process into your budget for coming years. Making sure that your bookkeeping function is reliable and up-to-date is especially important. Without numbers you can trust, your budget may be founded on a set of inaccuracies that skews your final results.
Hiring an experienced bookkeeper can help to ensure your numbers, and therefore your budgets, are accurate and dependable. Taking advantage of a technologically savvy bookkeeper offers an added bonus. Technology, such as cloud computing, can allow you to automatically link your accounts receivable (AR) and accounts payable (AP) to your budget-making process.