Budgeting for a small business can be intimidating, especially when you are just starting out because you need to figure out and track your income and expenses to be financially successful. This is also one of the many reasons why people don’t start a business in the first place.
Creating a budget for a small business is not that difficult if you take the right approach. So if you want to be successful, follow these six easy steps:
Review Your Revenue and Subtract Your Fixed Costs
The first step in budgeting for small businesses is figuring out how much money your business is bringing each month. This is regardless of how much you are spending to get there. Look back at all of your income and revenue sources. It can be based on your average number last year. Add all of those to discover how much you earn monthly. Make sure that you calculate your revenue and not your profit.
Revenue vs. Profit: An Overview
Understanding the difference between revenue and profit can determine whether your business is earning or losing money. So, what are the differences between these two? Here’s a simple explanation.
Revenue
The revenue, referred to as the top line, sits at the first section and top of the income statement. It is the summary of the total gross sales of your business before any expenses are subtracted. In simple terms, it is the money you receive from exchanging your goods and services. Use the following formula to calculate business revenue:
Revenue = Quantity x Sale Price
For example, your company sells 200 purses every month for $50 each, your revenue from selling purses is $10,000.
Profit
Your business profit, also referred to as net income on the income statement, is the total amount of money earned after deducting business expenses. These expenses are the amount spent in buying, operating, or producing something. The profit is also informally called “the bottom line” because it is found on the last or bottom line of the income statement. Use the following formula to calculate business profit:
Profit = Revenue – Expenses
Let’s use the previous example in which you’ve earned $10,000 in sales revenue. Imagine that your monthly expenses, including your purses’ raw materials, are amounting to $3,000. In this case, your total monthly profit is $7,000 even if you sold $10,000 worth of purses.
Determine Variable Expenses
Variable costs are expenses that vary depending on the volume of activity of goods a business is producing. Meaning the variable costs increase when the activity of goods increases and decrease when the activities decrease. Fixed costs, on the other hand, remain the same regardless of production output. The most common variable costs are:
Raw materials
These are materials and supplies that are used during the manufacturing process of a product. This type of expense fluctuates depending on the cost (increase/decrease) of the raw materials of products produced.
Labor or Staff Wages
This is the amount paid to workers in producing products. It is a semi-variable cost since wages are paid to workers, making this a fixed cost.
Production Supplies
These are the supplying components of the machinery or work centers during the production process. Examples are shipping materials, papers, pens, and the like.
Freight-out
This is the cost of delivering the finished products sold to the customers.
These are the necessary expenses (cost) for your business to stay in operation. Therefore, you can increase your variable costs spending during profitable months and decrease your spending during lean months.
Forecast One-Time Spends
As mentioned earlier, there are fixed and variable expenses that you pay monthly. But some expenses happen less frequently, and you need to factor that expenses into your budget as well. This is called one-time spending. Adding this to your budget can help set aside money to cover these expenses and protect your business from large financial losses.
The one-time spends are usually the startup costs. For example, you buy a new computer, equipment, software, and other expenses related to your business launch.
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Set Aside an Emergency Fund for Unexpected Costs
Some expenses arise when your budget is tight and when you least expect them. Setting up an emergency fund makes sure that you have extra cash on hand and prevents fear of unexpected costs.
How to Create a Business Emergency Fund
These are different ways to set aside money to help you build up your business’ emergency fund.
Start Small
When it comes to saving for an emergency fund, setting a small achievable target can keep you on track with your emergency fund goal. One effective technique is to put 10% to 30% of annualized revenue towards your emergency fund.
Save Regularly
You should deposit a specific amount based on your goal into your account monthly or quarterly, and pretending your emergency fund doesn’t exist can help you save without having to overthink that you are missing out on extra money.
Keep Saving During High Business Times
It can be tempting to reward yourself by spending money when your business is booming. However, you should stay on track to save even more money during the good times and not go on a spending spree with your extra revenue.
Reduce Expenses
If you do not have enough money for your emergency funds, you can go through your expenses line by line to cut back on unnecessary expenses. This will free up some cash to set aside for your emergency funds.
Separate Business Emergency Fund and Personal Savings Accounts
A common business mistake is combining your personal savings with your emergency funds accounts. Unfortunately, this is a recipe for disaster because when these two accounts are combined, you may think that you have enough money in the bank for an emergency, and it can also be hard to distinguish how much reserved cash you have for your business emergency funds.
Automate Your Savings
Set up an automatic savings plan by having the bank automatically transfer a specific amount into your emergency savings account.
Your business emergency funds are only for emergencies. You can use some of your emergency funds for an unexpected business shutdown, months when your business is crawling slow, or if you decide to pursue opportunities to make an income.
Create Your Profit and Loss Statement
The profit and loss statement is the financial statement summarizing your revenues, expenses, and costs on a specific period, usually quarterly or annually. You can collect all of the above information and put them all together to develop your profit and loss statement.
This record provides the necessary information about your business’s ability or inability to generate profit by reducing cost, increasing revenue, or both. Here are the steps to take to create a profit and loss statement.
First, calculate revenue and your cost of goods sold. Next, subtract the cost of goods sold from revenue to determine gross profit. Then, calculate operating expenses. Finally, deduct operating expenses from gross profit and hope that you have a good number.
It’s okay if you didn’t get a good number, as small businesses aren’t always profitable every month, especially when you are just starting.
Outline Your Business Budget
The profit and loss statement you’ve created will show the historical profit performance of your business. Once you have this information, it’s time to make your budget, and it should be future-focused.
By referring to your profit and loss statement, you will better understand which investing in your business is worth replicating and what past mistakes you should avoid. This will also determine which purchases are beneficial losses, seasonal trends, and fluctuations and changes in your business.
What Should a Small Business Owner Do?
Budgeting for a small business requires you to carefully track your income and expenses to ensure that you come up with the correct profit margin. It can be daunting at first, but you make budgeting efficient to get back on operating your business.
You can start investing in online accounting courses and accounting software like Quickbooks to track your income and expenses and automatically create your profit loss statement. This will save you time and money as it allows you to pool all your data in one place.
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