Hearing the word “budget” often conjures the image of belt-tightening. But small business budgeting is the down-to-earth process of planning for the growth and profitability of your business. It’s about translating ideas and predictions into numbers. The ROI of thoughtful budgeting includes being able to secure financing to help accelerate your growth.
So how do you go about the process of small business budgeting?
There are different approaches, but here’s one. First ask yourself: Am I where I want to be next year? If yes, that’s great, but you can’t just create your next year’s budget from the last year’s profit and loss statement (P&L). You need to think about the reasons for the results you had. Next, you need to make your best guess as to whether they’ll hold up going forward. For example, you might ask yourself questions like:
- Is it safe to assume that the competitive landscape will remain the same? Or do I need to prepare for the possibility that competition will heat up?
- Will I need to make any enhancements to my products or services to keep up with market conditions and technology?
- What changes might occur in my staffing needs? If I have to replace any key workers due to resignation or retirement, how will that impact my payroll?
- Can I count on no big changes in the cost and prices of the goods and services I consume to keep my business moving forward?
- Is any of my equipment wearing out or becoming obsolete?
- Should I plan for any changes in the economy, for better or worse?
Chances are, your answers to some of those questions will point to the need to roll up your sleeves, sharpen your pencil and get to work on a new budget.
Budget for Revenue, Profit Growth
Start with revenue, using the revenue categories on your P&L, assuming it’s reasonably detailed. Revenue is the hard part, but it’s also what largely determines the expense side of the budget. Before you start plugging numbers into a spreadsheet, think about and determine which of your products or services…
- Are the most profitable?
- Are the ones that you’re best at making or performing, and give you the greatest competitive advantage?
- Have the greatest potential for market growth?
- Are most likely to be in demand for a long time?
- Can expand your capacity to produce or perform?
Then think about new products or services that you might want to introduce. What would it take to do so? And how quickly you can generate revenue from them?
Turn a Business Plan into a Budget
These questions are the foundation of a business plan that can be translated into a budget. It might be a multi-year budget, but the process forces you to become a strategic thinker. Or, at the very least, it will allow you to translate your existing strategic plan into something concrete.
Next on the revenue side of budgeting comes this question: How conservatively or aggressively do you want to predict your revenue for the coming year? It’s a balancing act, and depends partly on your personality. It’s OK to be somewhat “aspirational” but without living in a dream world.
If you’re planning to borrow money or seeking to draw in some equity capital from outside investors, you might choose to be somewhat conservative. It’s usually better to under-promise and over-deliver, than the other way around. Besides, it can be very disruptive to business operations when you overestimate revenue, then have to retrench on spending midstream to protect your bottom line.
Also, you can give your sales team revenue goals that exceed your budget. This lets you aim high without going out on a limb.
In picking revenue numbers, take your recent actual numbers within each product or service category, check to see how good you were in the past at predicting future sales, and learn what you can from the forecasting process you have used so far.
Forecasting Budgeted Revenue
If this is the first time you’re making a detailed budget, take your current revenue pattern and do your best to predict the impact that all the variables that go into sales results will have in the next year. Naturally, it’s easier to do if you’re not planning to make any big changes in strategy, such as raising prices, adding new products and services, increasing your sales and marketing efforts, opening new offices, and so on.
The small business budgeting process for expenses generally follows the revenue part. An exception would occur if you were forced into budgeting higher revenue (and figure out how to generate it) by an expected big jump on the expense side, such as a major increase in the cost of an important input. For example, higher import tariffs on goods from China are having this effect for some businesses. Others may be facing higher local minimum wage standards, or steep increases in health benefit costs.
As on the revenue side, you can use your P&L as the foundation for your expense budget. If you’re not planning any big changes in your business for next year, expense budgeting can be fairly straightforward. Certain changes in expense categories can be predicted, such as wage raises you plan to give, or additional staff you plan to hire. Other categories like rent and utilities generally aren’t hard to predict.
If you’re trying to improve your bottom line and aren’t expecting a surge in revenue, you’ll need to find savings on the expense side. If instead you’re expecting a significant increase in revenue based on a new business plan, you’ll need to incorporate the new expenses associated with the plan to build that revenue. It might be something as basic as higher sales commission and bonus expenses, or that plus many other expenses.
Don’t Neglect a Cash Flow Forecast
Small business budgeting also includes a critical component sometimes overlooked: cash flow forecasting. You might come up with a realistic budget that shows a healthy profit at the end of the year. But without a cash flow budget, you could find yourself with a depleted bank account and suppliers hounding you. That’s because your expenses and revenues rarely come in at the same rate every month.
You might accurately budget a big jump in sales in June, and some correspondingly higher vendor bills and payroll obligations that must be dealt with promptly, but the actual cash generated by those increased sales doesn’t come in before late August. A cash flow forecast will alert you to whether, without drawing on other resources, you’ll have enough money on hand to pay those bills.
And if your cash flow forecast points to a need for extra funds to tide you over a dry spell, it’s time to begin a conversation with a small business lender who can help you address that need. The better your budget and cash flow forecast, the better your prospects for a productive relationship with such a lender to help you achieve your business objectives.