In their book Start Your Own Business, the staff of Entrepreneur Media Inc. guides you through the critical steps to starting your business, then supports you in surviving the first three years as a business owner. In this edited excerpt, the authors discuss the basics of creating a projected budget for your first year in business.
For many small-business owners, the process of budgeting is limited to figuring out where to get the cash to meet next week’s payroll. There are so many financial fires to put out in a given week that it’s hard to find the time to do any short- or long-range financial planning. But failing to plan financially might mean you’re unknowingly planning to fail.
Business budgeting is one of the most powerful financial tools available to any small-business owner. Put simply, maintaining a good short- and long-range financial plan enables you to control your cash flow instead of having it control you.
The most effective financial budget includes both a short-range, month-to-month plan for at least a calendar year and a long-range, quarter-to-quarter plan of at least three years that you use for financial statement reporting. It should be prepared during the two months preceding the fiscal year-end to allow ample time for sufficient information-gathering. The long-term budget should be updated when the short-range plan is prepared.
Many financial budgets provide a plan only for the income statement; however, it’s important to budget both the income statement and balance sheet. This enables you to consider potential cash-flow needs for your entire operation, not just as they pertain to income and expenses. For instance, if you had already been in business for a few years and were adding a new product line, you’d need to consider the impact of inventory purchases on cash flow.
Budgeting only the income statement also doesn’t allow a full analysis of the effect of potential capital expenditures on your financial picture. For instance, if you’re planning to purchase real estate for your operation, you need to budget the effect the debt service will have on cash flow. In the future, a budget can also help you determine the potential effects of expanding your facilities and the resulting higher rent payments or debt service.
In the startup phase, you will have to make reasonable assumptions about your business in establishing your budget. You will need to ask questions such as:
As for the actual preparation of the budget, you can create it manually or with the budgeting function that comes with most bookkeeping software packages. You can also purchase separate budgeting software such as Quicken or Microsoft Money. Yes, this seems like a lot of information to forecast. But it’s not as cumbersome as it looks.
The first step is to set up a plan for the following year on a month-to-month basis. Starting with the first month, establish specific budgeted dollar levels for each category of the budget. The sales numbers will be critical since they’ll be used to compute gross profit margin and will help determine operating expenses, as well as the accounts receivable and inventory levels necessary to support the business. In determining how much of your product or service you can sell, study the market in which you’ll operate, your competition, potential demand that you might already have seen, and economic conditions. For cost of goods sold, you’ll need to calculate the actual costs associated with producing each item on a percentage basis.
For your operating expenses, consider items such as advertising, auto, depreciation, insurance, etc. Then factor in a tax rate based on actual business tax rates that you can obtain from your accountant.