Small Business Thoughts

A business budget is a tool that can be used to track and manage a company’s finances. It allows the company to see where its money is going and where cost cuts can be made. A budget is also a tool to help when planning for future expenses. Every good budget should include six components:

1. Estimated revenue

• This is the amount you expect to make from the sale of goods or services. It’s all of the cash you bring in the door, regardless of what you spent to get there. This is the first line on the budget. It can be based on historical data like last year’s numbers or, for a startup, based on industry averages and market research on comparable businesses.
• For businesses that have been in existence for a year or more, take some time to analyze seasonal trends. If the business is new, do some research on patterns within your industry. Many businesses experience a boom in sales at Christmas, followed by a lull in January. It’s important to plan for these peaks and troughs as accurately as you can. Remember that revenue forecasts are rarely accurate. The point is to provide the best possible estimate using the knowledge you have. Always be conservative. This means assume you will receive sales volumes and pricing on the low end of the possible range.

2. Fixed costs

• These are all your regular, consistent costs that don’t change according to how much you make—things like rent, insurance, utilities, bank fees, accounting and legal services, and equipment leasing.

3. Variable costs

• These change according to production or sales volume and are closely related to cost of goods sold (COGS), i.e., anything related to the production or purchase of the product your business sells. Variable costs might include raw materials, inventory, production costs, packaging, or shipping. Other variable costs can include sales commission, credit card fees, and travel. A clear budget plan outlines what is expected to be spent on all these costs.
• The cost of salaries can fall under both fixed and variable costs. For example, usually core in-house employees are usually associated with fixed costs, while production or manufacturing employees (anything related to the production of sales units) are treated as variable costs. Make sure you file the different salary costs in the correct area of the budget.

4. One-off costs

• One-off costs fall outside the usual work that business does. These are startup costs like moving offices, equipment, furniture, and software, as well as other costs related to launch and research. These are expenses that are only paid once.

5. Cash flow

• Cash flow is all money traveling into and out of a business. There is positive cash flow if there is more money coming into the business over a set period of time than going out. This is most easily calculated by subtracting the amount of money available at the beginning of a set period of time and at the end. Cash flow is the money that is available to pay business expenses. This includes money from sales, investments, and other sources. When estimating cash flow, be sure to include all of the necessary sources of income for the business. Since cash flow is the oxygen of every business, make sure it is monitored weekly, or at least monthly. I have seen businesses that were raking it in and still did not have enough money on hand to pay their suppliers.

6. Profit

• Profit is what the company makes after deducting their expenses from the revenue. Growing profits mean a growing business.How much profit that is planned to to be made is based on the projected revenue, expenses, and cost of goods sold.
• If the difference between revenue and expenses (aka profit) aren’t where the company wants them, it needs to rethink the cost of goods sold and/or consider raising prices. If the business can’t squeeze any more profit out of the business, consider boosting the advertising and promotions line in the budget to increase total sales.
• In order to calculate net profit margin, the business’ net profit (this is the dollar amount left over after expenses are deducted from gross income) and the total revenue (aka total sales): Net Profit margin = Net Profit / Revenue. Net profit and gross sales numbers can be found on the income statement (one of the essential financial statements, along with the balance sheet and cash flow report).
• Gross profit margin shows the relationship between revenue and gross profit. In other words, gross profit margin is the portion of each dollar kept after paying for the cost of making your product (Cost of Goods Sold, or COGS). Gross profit margin ratio = Gross Profit / Revenue.
• While net profit margin and gross profit margin both show profitability, they’re doing so in different ways and shouldn’t be used interchangeably. Net profit margin shows how profitable the products, services, or business is after deducting both direct and indirect costs. In other words, net profit margin tells how profitable the whole business is. Gross profit margin shows how profitable the products/services are after deducting only direct costs. That is, it tells you how well your pricing strategy is earning money—but not how the internal operations affect profit.
• Example: If the company has a healthy gross profit margin (say, 50%), but the business is losing money, it knows it needs to cut costs. The products are profitable, but the fixed cost (aka overhead) is too high. Always look at net profit margin in connection with gross profit margin to understand if the problem is unprofitable products, or something else in the business. By the way, net profit margin isn’t just for the company’s internal use. It also gives people outside the company a clearer picture of the business’ financial health.

A budget doesn’t mean much if it isn’t reviewed regularly. A lot can change in a surprisingly short amount of time. It’s vital to keep checking the budget and making adjustments whenever necessary. Each month, set aside some time to check the financial statements and compare them against the plan. This will keep the company on track and allow it to keep the budget relevant to the business.

A budget is an important tool for any business owner. It should be reviewed on a regular basis. By taking the time to create a budget and review it regularly, owners can ensure that their business is on the right track and making sound financial decisions.

Be sure to try the SCORE Financial Template and the SCORE Financial Template Guide.

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