Approximately 60% of small businesses operate without a formal budget. Maybe you thought you didn’t need a budget because you are running a successful business or you thought you were too small to worry about it. The reality is every business should have a budget.
Creating a budget is not nearly as complicated as it may seem. In several steps you can create one that the business can operate against. Reviewing actual results compared to your budget will help you understand where the business is thriving and where it can improve.
Let’s work through the steps of building a budget for a standard small business. We will focus on a business that has existed for more than 12 months.
Step 1 – Look Backwards and Do Some Research
The best starting point is to look at what has happened over the past 12-24 months. These results won’t necessarily equate to what will happen in the future, but they are a great starting point. They will help identify trends and will help you to understand your spending patterns.
Research! Talk to your peers and even your competition about their experiences. This is especially important if they have been in business longer than you. It’s possible your business will start to change as it matures. Maybe it will look significantly different and face different problems in years four through six compared to years one through three. Don’t forget your franchisor. Franchisors accumulate data. That data can be very useful as you plan out future years.
You will take all these learnings and begin to build your forward looking budget.
Step 2 – Revenue
It’s time to apply what we learned in Step 1. What trends did you identify? Does your business have any seasonal or holiday trends that should be incorporated into the budget? Many businesses I work with have significant gift card sales. These businesses tend to see significant gift card revenue spikes around Valentine’s Day, Mother’s Day and Christmas.
You will start to build your revenue budget by evaluating the past. If your business is mature you can look at same month last year sales. If your business is relatively new you can look at the past couple months of revenue as the starting point. From there you can add projections related to revenue growth or revenue declines based on your research and trends within the industry.
Step 3 – Variable Costs
Variable costs tend to be tied very closely to revenue. Things like materials, billable hours, commissions, merchant processing fees, and franchisor expenses are common examples of variable costs. As revenue grows, these expenses will grow as well, generally in direct proportion to the sales growth. If revenue declines, expenses should follow this trend as well. Keeping a close eye on expenses as a percentage of revenue is important related to variable costs. Generally speaking you wouldn’t expect to see significant changes in the percentages month over month.
Step 4 – Fixed Costs
Next up are fixed costs. These costs are those that don’t change a whole lot month over month. Common examples are rent, utilities, insurance and interest expense. These expenses tend to be flat and predictable.
Step 5 – All Other Costs
What about everything else? There are many expenses that could fall into either category. Instead of debating which is more appropriate I think we lump them all together in the “all other costs” bucket.
I view these costs as largely controllable and probably the best opportunity to find quick improvements to your bottom line. These costs should be evaluated regularly to ensure the dollars spent are adding or creating value in the business. Examples of these expenses are marketing, advertising, training and office supplies. These costs are clearly operational in nature and necessary, but how much and how much value they bring should be evaluated on a regular basis.
Step 6 – Unusual Purchases
Do you have significant expenses coming up that aren’t part of standard operations. Maybe you need to buy a new piece of equipment or need to refresh your store. Don’t forget these irregular expenses when you build your budget. The last thing you want is to be operating a profitable business only to have a significant cash outflow related to a capital purchase that you hadn’t planned for. This is especially true for a fixed asset purchase because oftentimes you don’t see a revenue pickup from these purchases.
Step 7 – Cash Is King
How much cash do you have now? How much cash would you need to survive if your revenue stopped or was significantly reduced? These are always good questions to ask yourself, but may never be more important given the unprecedented times we are operating in.
We know that individuals should have an emergency fund. Businesses should as well. If your business is shut down due to COVID or some other disaster how long could you survive without help from the government?
Now is the time to build your cash and prepare for something to significantly impact your business. It may be COVID related or it could simply be consumer behavioral changes. This is not an easy topic to think about, but it deserves your time and attention.
Step 8 – Bring It All Together
You’ve gone through your historicals in detail. You’ve done your research. You have evaluated your cash position and big purchases that need to be made this year. Now it’s time to put the budget together.
How you actually put the budget together will be based on a variety of factors. Do you have an accounting system that includes a budgeting tool? Do you work with an accountant that can help you? More often than that, I utilize excel or google sheets when putting a budget together. I like these tools because they typically allow you to do more than most budgeting tools. Specifically, I like to create an income statement budget that also includes a cash forecasting analysis. This can be done fairly easily in excel or sheets, but typically not as easy in a canned budgeting tool. You should do what makes the most sense for you. You need to to understand and be comfortable with the budget you’ve created. Luckily building the tool should be a one-time event.
Step 9 – Stay On It
The worst thing you can do is build a budget and then forget about it. Make sure you update it each month with your actual results. Take the time to dig in where things aren’t making sense. Don’t forget to use your “gut” when looking at the results. If something doesn’t feel right, make sure you take a hard look at it. You will be surprised what you find related to unnecessary spending that has been going on for years.
Periodically, I like quarterly, review your budget for reasonableness. If your actual results are significantly different than your budget in many areas you likely need to spend some time to revise your budget. There is nothing wrong with these revisions. You need to create a budget that you can hold yourself and your team accountable too. A budget is another tool that will help you manage your business effectively and maximize profitability.
BONUS Step 10 – COVID-19 Impact
COVID-19 has wreaked havoc on the small business community. The impact has been widespread and likely will continue to have a material impact on most businesses for some time to come. There are businesses that are entering their fifth month of being completely shut down, while others are doing as well as ever.
COVID will have an impact on how you budget the rest of 2020 and likely into 2021 as well. Take into consideration your industry and what is happening in your state as it relates to COVID testing. You should also consider politics. Politics will likely have a meaningful impact on closures, staying open, and what things look like when you are able to open.
The goal is to accumulate as much information as you can and incorporate it all into your budget. Staying on top of your finances has never been more important. If you need help, don’t hesitate to reach out to your financial consultant at firstname.lastname@example.org.