Did you know that nearly two-thirds of small businesses don’t make even a simple budget? This shocking statistic underlies one of the major reasons 20% of small businesses fail within two years of opening their doors. Much of owning a business involves understanding and forecasting cash flow, whether you like numbers or not.
Knowing your customers, your product or service, and being a good manager for your business are great tools to have in your tool belt. How good you are at using those tools reflects in your budget.
This could be why many small business owners are reluctant to make one.
You need a budget if you want to grow, get a loan, take on a partner, get a venture capitalist involved, or stay afloat. Today we’re helping you know the things to include in a budget and how to make them.
Grab your visor, a calculator, a lot of paper, and a pencil—the cigar is optional—it’s time to know what your business is made of!
First, it’s important to know that a budget is not like Google’s directions. It is a cash management tool to better understand historical data about your business, which will help you predict its future better.
If you can predict its future well, you can steer it to avoid some nasty icebergs. Of course, the world is changing in unexpected ways from day to day. We don’t even need to list the surprises 2020 gives us, do we?
While the IRS probably does want things to be accurate down to the penny, and accuracy is important, your budget doesn’t have to be quite so perfect. A rough idea of money in and out is fine, even rounding up or down to a reasonable level.
What is reasonable for you is up to you. We prefer not to round up or down more than a few hundred dollars if possible.
Income and revenue sound the same, but the two are very different to investors. Revenue is money that comes in due to sales or services. It is a “gross” amount that comes in before any adjustment.
Income in the eyes of any investor, including banks, makes them think of “net income” or profit. We aren’t quite at that stage yet, and that’s what a quick budget helps to determine.
2. Fixed Costs
Fixed costs are costs that are not fluctuating. They are predictable and rarely-changing costs of doing business.
Some of these costs include:
- Software Licenses
- Debt repayment
It’s also important to know how often these costs are made. Some payments are made weekly or monthly. Some might be yearly or by quarter (like taxes). If you just want to account for an average monthly cost of doing business, that’s fine too.
3. Variable Costs
Variable costs are costs that have variations in the price tag. Some might not fluctuate much, and if you want to create an average and move it into your fixed costs, you can also do that.
Some included expenses are:
- Payroll (unless employees are salaried)
- Owner’s Salary
A lot of “discretionary expenses” go here as well if it’s something that recurs often, but the amount is often changing. Of course, emergencies occur and might need special attention. We’ll get to that next.
4. One-Off or Emergency Costs
One-off expenses, or even emergencies, require a different category altogether. Moving costs for going from one office space to another or plumbing issues would go here. You can’t predict what will happen around you at any given time.
Make sure to account for it and be prepared for it! It’s different for businesses than homes, but some estimates for homes are $1/sqft as a maintenance cost per year. You can also use that number to know how much you should have on hand for an emergency.
While households and businesses are different, you can use the same methodology by considering what your business uses daily for necessary functions and planning on replacing one or two of the most expensive things per year. Find out the cost, and saving for that particular rainy day might be good.
5. Run The Numbers for Profit and Loss
You have all your total numbers. Now what? Now we start our formula.
Revenue comes first. Subtract fixed cost from your revenue, then your variable cost from your new total. Even if you haven’t had an emergency, subtract that from your total, and you have your profit—or your loss.
Profit and Loss (P&L) statements are necessary for banks and other investors to know whether or not to invest. It doesn’t matter how much you sell. Rather, it matters to them how much profit you make.
6. Prospect for the Future
No one has a crystal ball, except for Warren Buffet, perhaps.
But a budget is a good judge of business health in the past and a sign you might need to do more. It is constructive to add sales data like new clients and client churn. This helps get a better idea of where your business is succeeding and where it can do better.
Otherwise, planning to reach a goal in the future will be much more difficult. When you don’t reach that goal (if it is reasonable), making a new budget and comparing the two can give a good roadmap of where you went wrong and how to fix it.
In other words, budgets are not a one-and-done solution.
Now You Know: Things to Include in a Budget
While the sixth item might be an optional step, it’s essential to have a plan. Knowing what to include in a budget and which are just extra distractions can sometimes be tough, but now you’re prepared.
Five things aren’t too many to remember, and you can even do it on the one hand. Remember—Revenue, Fixed, Variable, Emergency, P&L.