As an entrepreneur, you are filled with energy, passion, and a drive to succeed, but it’s likely safe to assume your dream didn’t involve crunching numbers and creating spreadsheets. Although budgeting may not be the reason you became an entrepreneur, it is a necessary part of creating and maintaining your business.
It’s easy to feel overwhelmed by the sheer number of budgets and budgeting methods. There are operating budgets, cash flow budgets, financial budgets, static budgets, etc. The list goes on and on.
Budgeting is all about predicting what your future finances will look like based on your previous revenue and expenses, as well as an educated guess of how your business will fare in the upcoming months. It’s not possible to see into the future, but with the help of an effective budget, you can gain a pretty good idea of what lies ahead.
When speaking to entrepreneurs, it’s obvious when someone has a clear sense of where their business stands financially as opposed to someone who doesn’t. Without a short-term monthly budget and a long-term annual budget you’ll be going into each fiscal period blind. Do you have enough cash on hand to pay back suppliers? What about taxes at year-end? At what point do you become profitable? How much excess cash do you have to reinvest?
Taking it one step at a time makes the process manageable. Determining your revenue is a good way to start. Look at your previous revenue sources and track where the money was coming from. Remember, you’re trying to identify revenue, not profit. Once you’ve figured out all your revenue streams, calculate your monthly income for at least 12 months.
Seeing how your revenue fluctuates month-to-month is a good way to identify the peaks and patterns that your business goes through. Maybe your ice cream store has higher sales in the summer, or your Christmas product experiences low sales when it isn’t holiday season. Understanding consumer behaviour and why sales change can help you prepare and adjust your production as needed.
The number you’re looking at is only gross revenue. Sadly, this isn’t the amount you will get in your bank account. Every product or service comes at a cost, which can either be fixed or variable.
Fixed expenses are the costs that don’t change month to month. Examples are rent, or insurance. An easy way to think about fixed costs is this: if you shut down production for a week, what would you still need to pay?
Variable expenses are the opposite. They fluctuate based on circumstances and usage. Examples of variable expenses are salaries, supplies or utilities. Generally speaking, the more products you produce, the higher your variable expenses will be.
So you’ve determined your revenue and calculated your expenses. Subtracting your fixed and variable expenses from your revenue will give you net profit. This is money in the bank.
Before you start reinvesting or using that money, don’t forget to set aside cash for taxes as well as a contingency fund. Many entrepreneurs don’t think about the taxes they will incur at the end of the year. By putting aside some cash, you’ll avoid the stress of wondering where the money will come from to pay them and potentially avoid late fees, as well.
Using the numbers you calculated, you can extrapolate the data to predict a budget for the upcoming months. Look for trends and consider any anticipated big purchases, such as equipment, and incorporate them into your budget.
If you do not have previous financials to look at or if you’re starting to create a forecasted budget, follow the same process but with estimated numbers. Estimate your monthly revenue and expenses by determining the following: How much do you think can be sold in your first year? What is the cost of producing each product? How many employees will you need? What about facilities, equipment and training? Which expenses are fixed and which ones are variable?
Keep all of your receipts – every single one; doing so will save you a lot of time down the road. Don’t be afraid to negotiate prices with your suppliers to cut costs. It doesn’t hurt to ask – the worst they can say is no.
Creating short-term monthly budgets for the upcoming fiscal year and long-term annual budgets for the next three years is ideal. It’s up to you to decide if you want to keep your budgets static or if you will adjust them as necessary. Say you get an unexpected purchase order or a machine breaks down. Adjusting your budget helps your forecasts stay accurate and reliable, but a static budget will show you how much you deviated from the initial plan.
Starting a new business is exciting, but hard. There are a lot of unknowns and things you have to learn along the way. Budgeting early and consistently will remove part of that stress and give you the assurance that your financials align with your goals.
For more resources and tools, check out BDC's website or come visit our lab at Communitech.
