Last Updated on April 25, 2022
Budgets are necessary when trying to optimize your business. Without a goal and understanding of your income and cash flows, a business budget is essentially an aimless savings account with no intended purpose.
When budgeting, you must know and understand what money is available to you, how much you spend, how much you can acquire, and how much you need to distribute into other areas.
Benefits of a Business Budget
A business budget is essentially a plan for your money. This budget plan doesn’t have to be complicated and extravagant, but it should cover a few basics. Typically, budgeting will help you with a few things:
- Increase revenue
- Help you increase cash flow
- Create investment opportunities
Budgeting is critical to business success because, without money, businesses wouldn’t exist. Companies can’t survive if they spend more money than they make. They make a budget with the knowledge of their revenue and expenses. How does a business ensure that they don’t spend more than they make?
Creating this budget will successfully filter excess income into investment opportunities while increasing revenue and cash flow.
Creating a Business Budget
The first important step to creating a budget is understanding your costs and revenue. Understanding how much money you make is the first step. On average, you’ll calculate your monthly income with monthly expenses. Doing so will allow you to correctly figure out where you can budget for your expenses and investments.
When creating a business budget, it’s essential to understand a few concepts.
You’ll begin by estimating your monthly revenue. You’ll do this by subtracting your expenses from the amount of money you’ll be making. Income may fluctuate during this estimation period because of unreceived invoices and receivables.
Calculate your revenue from assured invoices paid by the end of the month. This estimate will vary if some payments don’t go through, and that’s fine. You should take that total revenue and subtract 15% of it. Doing so will allow a margin of error. The margin can be lower if you feel sure that a big safety net is unnecessary.
The percentage you subtract will become a safety net for additional variable costs and emergencies. The larger the ratio, the more flexibility your budget will have. The lower the percentage, the more strict your budget will become.
Subtract Fixed Costs and Variable Costs
The next step in creating a reliable budget is to subtract your fixed costs followed by your variable costs.
Fixed costs are what you expect. They’re expenses that will remain constant throughout your operating periods. Expected fixed costs are rent, banking fees, insurance, services, licenses, and leases.
There are considerable fixed costs, but you correctly identify them by understanding the length of payments and the amount over some time. Fixed costs can disappear, but they’ll stay consistent, so you know what you’ll be paying with no surprises.
Variable costs are another category of expenses. Variable costs consist of items or services that change in price. These variable costs are a bit unpredictable, and they may interfere with your budget planning.
Common variable costs are manufacturing, shipping, labor, travel fees, and raw materials. The reason these costs vary is that they’re dependent on other factors. For example, if a job becomes too difficult or easy, labor costs will fluctuate because of hourly rates and other optimization adjustments.
Raw materials will always vary depending on how easy or expensive they are to obtain. Shipping costs follow a similar trend because gas prices fluctuate, which means travel costs will also increase or decrease depending on distance, gas prices, and vehicle maintenance.
Profit and Loss Statement
You’ve now calculated your revenue and identified your expenses. Assuming you’ve covered all that ground, you’ll be able to create your profit and loss (P&L) statement. The P&L statement will give you an idea of what you can do with leftover cash and where you could mitigate loss or increase revenue.
This statement is the key to increasing cash flow and budgeting properly because it creates a snapshot of your company. You can plan around this statement and budget accordingly.
Points of interest are as follows:
- Inventory purchasing
- Licensing costs
- Seasonal revenue changes
- Yearly revenue changes
- Expense changes
Examining the Profit and Loss Statement
There are numerous things to look out for, but you as a business owner want to keep a few things in mind. The main purpose of the P&L statement is to give you the information to redirect your funds to more pressing needs.
If you’re trying to budget to meet the upcoming demand of a holiday rush, you may start looking for ways to increase production. You would do this by cutting unnecessary costs and investing money into your equipment and labor costs to meet the demand of the holiday rush.
Capturing revenue is another vital purpose of the P&L statement. Whether mitigating expenses or finding opportunities to expand, it’s essential to review and adjust your business budget to reach your goals.
Limitations of Budgeting
Like any plan, budgets have inherent flaws, and that flaw is being unable to predict the future. Not everything will go according to plan, and because emergencies and variable costs exist, you may find yourself adjusting around those costs often.
To mitigate these weaknesses, it is recommended to leave emergency funds to compensate for a lower than average revenue or higher than average expenses. Important to note that sometimes emergency funds act as idle cash, and some businesses may not like the idea of idle cash lying around.
Putting that emergency cash into a savings account will allow it to accumulate interest while also acting as a safety net for potential emergencies.
The first budget you make will consist of estimates, but as your year comes to a close, you’ll begin to have a stable and more accurate foundation to help with your budget.
Sometimes budgeting is a trial and error process, but the more accurate your numbers become, the more reliable your budgets will become.
Every business budget must stay flexible. The business world is constantly changing and expenses along with it. When planning a budget, every budget should keep variable costs and estimates in mind. Ensure you’re setting proper goals and distributing your revenue accordingly. Expect the best, but prepare for the worst.
Jim is the General Manager of altLINE by The Southern Bank. altLINE partners with lenders nationwide to provide invoice factoring and accounts receivable financing to their small and medium-sized business customers. altLINE is a direct bank lender and a division of The Southern Bank Company, a community bank originally founded in 1936.