Don’t Break the Bank: How to Create a Functional Small Business Budget
According to a study, an astonishing 82% of businesses
fail due to money flow problems. This is mostly due to poor resource management and accounting.
Small businesses are more at risk of running into money problems than large enterprises due to relatively low revenue and their urge for growth. Many small businesses blow all their income on unplanned expenses without having a clear projection of future income.
Careful planning of revenue and investment is vital to the success of small businesses and, indeed, any business. Therefore, it is essential to have a business budget.
A budget ensures business financial stability through tracking of resources, income, and expenditures. Even more crucially, a budget helps shape a sustainable future for the business. Very little could go wrong with a solid handle on the business’ cash flow.
Let’s look at how to create a small business budget.
Master Budget and Functional Budget
Broadly, there are two types of business budgets – the master budget and the functional budget.
A master budget is a boiled down aggregate of all the business resources. It provides a big picture of all the financial activities within a business.
A functional budget covers the finances of a particular undertaking within a specific period. It may be a comprehensive budget for a single department or a single business operation.
As a small business owner, you should be looking at creating a functional budget for your operations. Typically, small businesses have few activities, so it makes sense to break down each one of them financially.
Creating a Small Business Budget
Creating a functional budget could help avoid financial mismanagement, which is one of the main reasons why businesses fail
. Here is how to do it in six easy steps.
1. Calculate your Revenue
The first step is to calculate all the revenue that the specific function brings into the business. Be sure, to sum up, all the gross income not the net profit. Gross revenue is the total income before deducting expenses.
Provided that relevant data is available, calculate the income for each month, preferably for the last 12 of them. In fact, if you can go further back, the better.
The idea here is to identify income trends. The more data you have to work with, the better the representation and credibility of patterns.
2. Determine the Expenses
Summing up all the expenses within a specified period, like say, a month can be a bit challenging. Expenses are dynamic, and you’ll be looking at three types of business expenses; Fixed expenses, periodic expenses, and variable expenses.
Fixed expenses are those expenses that the business and its owner have little or no control over. They are mostly legal obligations that must be paid within a specific period. These include insurance, taxes, loans, rent, and business licenses. Most fixed expenses are payable monthly or annually.
Periodic expenses occur within a particular period, but not necessarily monthly or annually. Like fixed expenses, the business has little control over periodic expenses. They include salaries and service fees that recur periodically.
Finally, we have variable expenses. These are expenses that change over time, depending on how much a certain function demands them. Most of these are necessary for business operations. They include the cost of supplies, marketing, and essential utilities.
Prepare all the expenses and quantify them on a monthly basis. You might have to do a lot of rounding off at this stage, but it's okay. This way, you can compare them to the monthly revenue in the next step.
Again, do this for as many months as possible.
3. Create a Profit and Loss Document
Having collected all the necessary information – income and expenses, it’s time to create a profit and loss statement.
Drafting a profit and loss assessment usually seems like a daunting task to many business owners, but it is surprisingly simple.
A P&L statement doesn’t have to be complicated. To prepare it
, all you need is to round up all the expenses and total revenue from each month. Then, subtract the value of expenses from the value of the income. Whatever remains is the net profit, or loss if the remaining number happens to be a negative value.
You don’t need sophisticated accounting software or extra help to make a profit and loss statement. The only tools you'll need are probably a calculator and a conventional spreadsheet. Spreadsheets are good at representing the final results visually in the form of graphs and charts.
The goal here is to work out how much money a particular business function brings in to the business, or how much it consumes from your pocket.
4. Identify Trends and Make Projections
With a profit and loss document prepared, it easy to identify business patterns through several months. Looking at the report, you can identify profitable periods, high expenses periods and low-income periods.
Determine whether certain times of year are better for the business. Depending on periodic characteristics, you can then make out probable causes for the cash flow behavior.
Using this data, you can anticipate similar trends over comparable periods and prepare for them financially. The pattern will also give you an idea of what needs to be done to lower the operational cost and increase productivity.
5. Allocate Resources Based on the Collected Information
A business budget aims to work out how to allocate resources and control the cash flow. Being able to predict income trends and the necessary inputs give you an upper hand at making informed decisions.
Use the information collected to identify areas that need more input and those that could do with less. By anticipating income, you know exactly how much you need out-of-pocket at a particular time, which lets you prepare for expenditures.
The Bottom line
Whether it is a startup business or an aged establishment, it's essential for entrepreneurs to create a small business budget. It's merely a matter of collecting data, evaluating it, and drawing useful conclusions to make financial decisions.
This practice may very well save your business from burrowing deep in debts, and possible bankruptcy. Manage your finances and avoid surprises.
If you liked this piece, check out more informative business-related articles like this one on our blog