How to budget better
by Yellow 701 Days
As with everything else, there are good things and bad about budgeting for small businesses. The bad news: Budgeting is one of the most overlooked aspects of financial management in small businesses. The good news: Budgeting is one of the easiest fixes for small businesses. Most small business owners seem to think that budgeting is something that's reserved for large corporations, but this couldn't be farther from the truth.
With the help of a good accountant, you can probably set your budgets for the year over a day or two, and monitoring these will help you understand your business' performance in a much clearer way.
At its very simplest, budgeting works in two ways. You want to attempt to budget for what's going out and for what's coming in. At the end of the day your margin as a business owner boils down to this. You always want to be in a position where what's coming in is higher than what's going out.
In general you also need previous years' numbers in order to budget more effectively. Don't despair if you don't, you can always set budgets based on gut feeling and some guesswork, however they won't be as accurate.
First of all you need to budget for your expenses. When budgeting for expenses it might be easiest to budget for overheads rather than costs of goods sold. So if you're a mechanic, for example, you want to budget for rent, equipment, wages and running costs of your garage, but you can't budget for parts - because you can't really tell what repairs you'll be carrying out.
To prepare a monthly budget there's a relatively simple formula - take whatever you've spent on these expenses over the past year (or years) and find the following things:
- What's the average amount you spend on these expenses every month?
- Has this been going up (or down)?
- Are there specific months with giant expenses that cover several months (such as rent or an insurance premium that's paid annually)?
- Has there been a freak expense in the past year which was a one off and might skew your average?
Once you've understood what your business costs to run, you should work on setting a monthly cost budget. This should ideally cover all your yearly expenses divided by 12 in order to give you a good picture of what you need to put aside to ensure that you can run your business comfortably.
Ideally you should then also set a projection of what you plan on spending every month - this will change from your original because it will be based on cash flow - i.e. here we want to indicate the month in which we'll be paying our annual rent, because that's where we're paying it, and we want to make sure we have enough money for it then.
This is a tougher cookie to crack in most small businesses. It is much harder to control the amount of money coming in than it is to influence money going out, so you're going to have to take a slightly larger leap of faith here.
Having said that, this is, arguably, more important to monitor because it is what affects your bottom line most. If you're overspending in comparison to your budget you can usually pinpoint where you're overspending. If you're not generating enough business the issue is usually far harder to pinpoint and subsequently fix.
This is why setting a sales forecast, although it is usually overlooked by many small businesses, can be a make or break factor for many businesses.
The level of detail you want to set for your sales budget depends greatly on the size of your business and the number of areas you have sales in.
If you're a tiny outfit that offers a restricted amount of services, then a general sales budget across your entire business should be enough. Larger businesses would probably benefit from splitting budgets more granularly to understand which areas of their business should be generating cash at what periods in the year.
Other than accounting for seasonality, the major target you should be setting is annual profitability. So you should be looking at your expense budget and setting an annual budget for revenue.
It is also incredibly important to factor everything into your sales budget to make sure that you're only counting your margins here. Try to include some leeway for unexpected expenses - you don't want to be caught out and lose all the hard work you've been doing just because you forgot to account for something unpredictable.
This is where it could get a bit more complicated, and this is where a good accountant can help you, however, this little example should help you understand:
- My expenses budget is €1000/month
- My income budget is €1,250/month - because I'd like to make €250 per month off my business
I'm a mechanic, I charge for my time, but I also make 10% margin on every part I sell.
If I've billed €500 for my time and sold €1,000 worth of parts, then I've only really contributed €600 (€500 + 10% of €1,000), even though my sales figures might show that I've gone above my budget.
I'm a grocery - I make an average of 15% on all my sales.
In this case I need to make sure that I've sold about €8,500 of groceries in a month (€8,500*15% = €1,275)
You need to make sure that you don't make a few crucial mistakes that are incredibly hard to fix as the year progresses and you dig yourself into a hole that's hard to come out of. Budgets will help you:
- Not overspend on expenses
- Plan for larger expenses that are not regular
- Realise if you're not reaching your income targets
- Set targets that are based on what you get to keep, not only on the value of items you're selling
- Help you be proactive rather than reactive to your finances.
Revising your monthly and annual budgets regularly to get a clearer, updated picture of your business finances is important. Even though all this might seem complicated, a good accountant can help you set out annual budgets and monitor them with you every month.