A good budget is one of the fundamental building blocks of a business. But putting together a budget for a business is much different than putting together a budget for yourself. Twenty percent of businesses fail in the first year, and one of the biggest factors is finances.
You need to understand business budgeting to keep your small business afloat.
A budget itself is pretty simple: it’s just your revenue and expenses measured over a certain period of time. You can use this information to plan your spending. But for new entrepreneurs, there’s a key mindset shift to conquer.
Running your own business is different from working for someone else’s company. Paychecks are usually steady, but you go through fat times and lean times with a company, and you have to manage your cash flow accordingly.
The first task of a budget is to figure out where all your cash is coming from and roughly how much you’ll make. Then you can move on to your next steps.
Understand Your Fixed vs. Variable Costs
The first thing you have to figure out is how much you’re going to spend. If you’re plotting out a monthly budget (likely, as most bills will come month by month), you need to figure out which costs are fixed and which are variable.
Fixed costs are the same every month — they don’t change much and they don’t tend to change without warning. These are things like hosting for a website, phone bills, rent, and payroll.
Variable costs are different from month to month and may spike or plunge unexpectedly. They usually vary based on how much business you’re doing. A variable cost would be something like gasoline for a lawn mowing business, shipping and handling for a dropshipper, or food for a restaurant.
Figure out which are fixed and which are variable and compare them to your revenue. Find a way to make the total of your fixed costs and your average variable costs lower than your revenue and you’ll be in business.
Set Aside Money for Expected and Unexpected Costs
There’s always going to be something unexpected. Maybe one of your fleet vehicles blows an engine and you have to buy a new one or something like that. Whatever the case may be, you want to have cash on hand to address the expense so you don’t have to rely on loans. Allow for that in your monthly budget.
You may be able to plan out some of these costs, too. For example, if you run a fleet of vehicles you should be setting aside money for their eventual replacements.
Plan out what you can and save for it. Leave wiggle room in your budget above your fixed and variable costs so you can set money back. It’ll save you headaches in the long run.
Don’t Confuse Money in Hand with Billings
You probably use bookkeeping software already, but there’s more to budgeting than just consistent bookkeeping. An overview of your accounting functions will let you find trouble spots before they become an issue. This will also help you to differentiate money people owe you from money people have already paid you, which is the key to staying on top of your cash flow.
A solution like vcita can give you a bird’s eye view of accounts receivable, pointing out which clients are regularly late or inconsistent on their payments. That allows you to make more informed decisions and deal with problematic customers. And if you can do that, your monthly financial picture will start to look a whole lot brighter.
If your business is in the service sector, then chasing after outstanding invoices can be a major drain on your time and can make you second guess the amount of liquid you can depend on for your operating budget. Using automated reminders and online payment processing can make all the difference here.
You Probably Won’t Make a Profit Every Month
You need a yearly budget to work towards, but you have to realize up front that your profits by month aren’t going to look flat. Every business has peaks and valleys that are often dictated by forces outside their control, and some months you might dip to the point where your expenses outweigh your profit.
Those are the times that you might need a short-term loan to tide you over if you don’t have operating cash set aside.
Just don’t be surprised when it happens. Set that money aside for a rainy day so you can tap into it.
Create Monthly Revenue Projections
Cash flow is critical when you’re running a small business. It does you no good to tell someone you’ll have a big job in 60 days when you need to pay them in 30.
A monthly revenue projection can help with this. Take stock of your sales, your product margins, the state of the economy and your industry. When you’re first starting out, it can be challenging to build an effective forecast since you don’t have much data. You’ll have to lean heavily on industry research instead of internal numbers until you get a few months under your belt.
Make sure you update on a monthly basis. Don’t just run with the same old projection … the landscape of your industry will change. You may launch a new product which should boost sales, or open a new marketing channel. Forewarned is forearmed, and this is one of the keys to staying ahead of the game.
Accounting isn’t a sexy part of business, but it’s an important one. Building an effective budget is essential to your success. Keep these five points in mind as you go through the process and avoid the pitfalls of business budgeting.