All small businesses should track where their money comes and goes. Budgeting, often a painful and tedious exercise, is crucial to ensuring your business can make ends meet. We set out below some key points small businesses should remember when organising their finances.
1. Understand Your Budget’s Purpose
Ultimately, a budget is more of an educated guess as to your expenditure. As such, you will need to refine your budget as you develop a better understanding of your incomings and outgoings. The assumptions you need to make to prepare your budget vary depending on the type of business you operate. For example, a small retail business running for three years will be better placed to forecast sales and expenses than a tech startup that has just launched. This is, in part, for two reasons:
- Historical data can provide a foundation for estimating future revenue and expenses; and
- Fewer variables mean a relatively simpler budget process.
2. Use Historical Data
Maintaining records of your revenue and expenses from previous years can act as a great foundation for developing your budget. This data will provide insight as to whether your business has been affected by factors such as seasonal changes, holiday periods or particular events. It also provides a snapshot of the expenses you incurred operating your business during this time.
For example, should you expect wage expenditure to increase during summer as you deal with a larger number of customers? Do you ship more products at Christmas? Although this data is useful, remember that past performance is no indicator of future performance.
3. Use Estimates and Variables
If you’ve been operating a retail business from the same shop, dealt with the same suppliers and maintained the same number of staff, then barring any unexpected changes such as a competitor opening across the road, you should be able to create a budget with a relative amount of confidence.
If you’ve just set up your business or are planning a big change, you’ll need to work out what your goals are and create a detailed business plan. For example, do you intend to develop a new product, create a new website, provide services in a niche industry? These factors will require you to predict the cost and time to develop the product/website or onboard your new clients. You’ll then need to estimate the revenue you’ll generate and the rate at which you’ll grow. This growth rate will affect costs such as rent and moving expenses if you outgrow your office and staffing numbers.
If you have ready access to information on competitors in your industry, you may be able to use information on their growth and development as a guide for your own. As your business changes, you’ll need to review your business plan and respond. You should also look to review your budget and update it in light of these new changes.
4. Be Realistic With Your Budget
Small business budgeting is a tool. It helps you plan for the future and also review how you’re performing. For this reason, it’s best to be consistent with how you evaluate your performance.
For example, if you run your Profit and Loss statement on a monthly basis then you should do the same for your budget. That will allow you to easily compare the two and revise as you develop a better understanding of your business.
After you’ve determined what your expenses will likely be and the revenue you expect to generate, you’ll need to be realistic with your estimates.
What is the margin of error that you’ll allow if any of your variables change? For example, if you predict sales of $100,000 p/a what is the realistic best and worst case scenario?
It’s best to err on the side of caution and pick a more conservative figure than an optimistic one. Being pleasantly surprised by the performance of your business is arguably better than being bitterly disappointed – it should also encourage you to keep your spending in check.
It’s most often easier to increase expenditure to service a higher demand than it is to scale back on expenses which often involve a contractual commitment.
5. Consider Your Common Expenses
The items you budget for will, of course, depend on the type of business that you operate. There are a few key budget items that will apply to a large majority of small businesses. For example, common overheads include expenses such as:
- Utilities (power, water, gas);
- Software/online services (Xero/MYOB etc.);
- Phone bills;
- Internet; and
- Vehicle expenses (repayments, insurance, registration, maintenance).
6. Consider Your Business Specific Expenses
In addition to these general overheads, there are a number of costs specific to different business types. For example:
- Variable costs to manufacture each item (e.g. raw materials);
- Shipping/handling; and
- Customs duties.
- Cost of goods sold;
- Shipping/handling; and
- Warehousing costs.
- Specialised software;
- External consultants/contractors; and
- Ongoing training/professional development.
7. Understand the Importance of Billing Cycles
It’s important to remember your bills are often charged on different cycles (e.g. weekly, fortnightly, monthly, quarterly or annually). Anything payable fortnightly (wages being the most common example) will most often be due twice a month, but a couple of times a year there will be a month with three pay periods. You should identify when this will occur for your business so that you’re not left wondering why your account is so empty this month.
8. Review and Revise
It’s been stated a few times above, but your budget is a work in progress. No one can predict the future. You should review and revise it often so you can better understand your business and (hopefully) more accurately forecast the money you can expect to receive and pay out.
How do you do your small business budgeting? Let us know your thoughts on LegalVision’s Twitter.