Sometimes when you own a business with only a handful of employees it can be tempting to fly by the seat of your pants when it comes to budgeting. However any business, no matter how small, can benefit from a business budget. This is how you make sure you are getting the most out of your money, which is essential for the growth of your business. Create a business budget.
Why Do You Need a Small Business Budget
Small businesses tend to start out with a smaller budget than big businesses. This gives you all the more reason to plan properly and make sure every cent is being put to good use.
A well thought out business budget will help you maximize the money going back into your business which can help you to support salaries and new positions. It will also help you manage cash flow, which will give you more reliable data and the ability to make educated financial decisions. A business budget is not just good for you, but for the whole team. With a clear budget, you’ll be able to communicate clear and concrete goals to your employees.
Let’s explore the basics of building a business budget.
5 Tips for Creating A Business Budget
1. Upgrade your Business Tools
If you want to get your finances right, it might be worth investing in third party business tools which will help you more easily organize and manage your budget.
Small business tools, like accounting and bookkeeping software, can help you enhance productivity and communication as well as providing financial insights. These tools will not only help you form a business budget but also make it easier to keep a thumb on your finances, to make sure you are sticking to the business plan.
2. Identify a Target Revenue
To build a business budget, you need to identify a target revenue. Target revenue is the revenue or earning which your company is targeting for a given period. This might be a year, a month, or a quarter. You want your target revenue to be aspirational but also practical and realistic. Once you’ve decided on a target revenue this will serve as guidance for the entire business budget. You might want to share your target revenue with the team or at the very least, with management to give them a goal and a purpose to work towards.
3. Calculate Operating Costs
It is important you know how much it costs to operate your business in order for you to price products and services accordingly and ensure maximum profitability. When calculating your operational costs, you should divide them into 3 key categories, fixed costs, variable costs, and one-time spends.
Fixed costs – Fixed costs are operational costs that do not increase or decrease based on the number of goods or services sold. Some examples of fixed costs for small businesses include rent, insurance, and utility bills. Even if your sales decrease by 50% one month and triple the next, fixed costs will not be affected.
Variable costs – Variable costs are expenses that will change depending on your company’s production volume. The most obvious variable cost is the materials used to provide a service or product. If you are a restaurant your variable costs will increase and decrease depending on how much food you are selling to your customers. The wages of your employees will also vary depending on the output. More staff working more hours equals higher costs.
One time spends – One time spends arise outside your company’s usual activity. For example, if you own a law firm, a one time spend might be making the decision to buy new chairs for your team. If you own a hair salon, maybe you decide to buy a coffee machine to provide an extra service to your customers. These costs are not part of your ongoing business expenses, you’ll only pay for them once.
4. Estimate Gross Profit Margin
Your gross profit margin is the percentage of revenue after accounting for the costs of goods sold. This figure tells you how much money is leftover from sales after operating costs. The gross profit margin can be used in a number of ways but most importantly it is the best indicator of your business’s financial health.
The gross profit margin is calculated by subtracting the cost of goods sold (COGS) from total revenue and dividing that number by total revenue and then multiplying by 100.
For example, let’s say your company has a total revenue of $500,000, and the cost of goods sold (material and labor costs) is $200,000. This means the gross profit is $300,000. If you divide this number by the total revenue you get 0.6, when you multiply that number by 100, you get 60%. This means that for every dollar of revenue, the business generates 60 cents in profits. This is a fairly healthy gross profit margin.
Gross profit is incredibly important to your business as it acts as a starting point that allows you to begin earning profits from basic business activities.
5. Readjust Your Business Budget
After calculating your operational costs, and estimating your gross profit margin you can apply this information to your target revenue. This is how businesses learn and scale over time.
Here are some other tips for making sure you hit your target revenue:
- Develop a SWOT analysis – This is a classic business technique that is used to identify your strengths, weaknesses, opportunities and threats. Business is unpredictable and even small changes can significantly impact your business finances. Performing a regular SWOT analysis will help you predict potential challenges and give you the chance to prepare in advance.
- Integrate your business tools – While once upon a time, small business owners would have to spend hours hunched over books every night to stay on top of finances, this is no longer the case, there are plenty of small business tools available that you can integrate to streamline finances and increase transparency and communication across your team. With the right tools, checking up on cash flow and expenses only has to take a few minutes.
- Communicate with your team – If you have employees or business partners you want to make sure you are all working towards the same goal. By providing your team with regular updates on whether you are on track to meet target revenue you’ll keep everyone motivated, it will also be more rewarding for everyone when you reach your goal.
When you finalize your business budget be sure to check out our Envelope Budget System –– putting your cash into physical/digital envelopes. This system is the most commonly used for budgeting at home but it is also a great way to budget for your small business.