Roughly 82 percent of small businesses fail in their first five years, many because they run out of capital. A key mistake some small business owners make is failing to create a budget, opting instead to use financial statements or bank account balances to assess the health of their business. But these documents offer a narrow view of your financials.
Creating a budget is an essential step in starting any business, big or small. Done properly, a budget provides a clear picture of your profitability, improves your cash flow and helps track progress toward your long-term business goals.
Follow these 10 steps to create a budget for your business:
1. Start now
A budget typically outlines revenue and expenses for one year, starting in January. But it’s never too late to start a budget. The key is to make time for budgeting, be diligent and revise your budget regularly.
2. Engage your team
Anyone responsible for managing the performance of the business should be involved in creating the budget.
3. Identify your long-term financial goals
Choose areas where you want to see your business grow in the coming year, and imagine how you’ll accomplish those goals. For example, your goal may be to double your online sales, grow your wholesale accounts revenue by $50,000 or cut your materials expenses by 10 percent. These goals should be specific and measurable.
4. Determine how you’ll reach your goals
Review your list of goals, and list the expenses you will incur on the road to reaching them. For example, if you plan to double your online sales, you may spend more on website hosting, marketing and advertising, and shipping costs.
5. Estimate your monthly costs and revenue
Gather your bank statements, financial reports, receipts and invoices from the past year, and use this information to forecast your budget for the upcoming year. Be sure to list both income and expenses for each month. Some expenses like insurance and utilities will be fixed and predictable, while other expenses like payroll and materials might vary from month to month. Fill in as much information as you can, and estimate where necessary.
6. Align your goals with your line items
Return to the goals you outlined in step three, and connect each goal with the revenue and expenses that support it. You can use a color-coding system in a spreadsheet to track these. This provides an at-a-glance view of your progress toward your goals.
7. Track your figures
Record your actual expenses and revenue as the year goes on. Experts recommend recording revenue in the month it’s billed or received, as opposed to when the product or service is sold. These actual figures may vary from your estimated numbers.
8. Adjust as necessary
Your budget should contain formulas that reveal whether you’re on track to achieve your financial goals, and whether you’re profitable in a given month. If your revenue and expenses don’t align with your projections in one month, adjust the following months to account for the increased costs or lost income, keeping an eye on your cash flow and profitability. For example, if you planned to receive payment for a large sale in March, but it didn’t arrive until April, increase your revenue in the next month’s column.
9. Make key decisions
When the time comes to decide whether you should invest in the growth of your business, pay off debt or pay yourself, look to your budget for answers. Your budget will provide insight into your cash flow and profitability, helping you decide whether your business can afford added expenses.
10. Plan for next year
As you near the end of the year, revisit your budget. Consider how your projected figures compared to your actual performance, and whether you achieved your goals. Use these insights to plot out your budget for the next year, dedicating the same time and effort to planning it.