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 has to do with 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 certainly are great tools to have in your toolbelt. How good you are at using those tools reflects in your budget.
This could be one reason so many small business owners are reluctant to make one.
If you want to grow, get a loan, take on a partner, get a venture capitalist involved, or stay afloat, you need a budget. 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 of all, it’s important to know that a budget is not like Google directions. It is a cash management tool to come to better understand historical data about your business, which in turn will help you to better predict its future.
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 make a list of 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 at all possible.
Income and revenue sound to be the same thing, but the two are very different to investors. Revenue is money that comes in due to sales or services. It is a “gross” amount of money 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 to 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 variation 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 do that as well.
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’s going to 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 taking account of what your business uses every day for necessary function and planning on replacing one or two of the most expensive things per year. Find out the cost, and it might be good to save for that particular rainy day.
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 extremely helpful if you add in 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 on how to reach a goal in the future will be much more difficult to accomplish. 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 a bit of an optional step, it’s very important to have a plan. Knowing what things 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 one hand. Remember—Revenue, Fixed, Variable, Emergency, P&L.
If you want to stay prepared and even get ahead, check out our other business and investment articles!