Setting a realistic business budget is an effective way to help keep your business profitable. Budgeting involves making revenue forecasts, estimating costs, and leaving enough room for reasonable profit margins.
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Part 1 of 3: Understanding Budgeting Fundamentals
Step 1. Get to know the budget
A budget can be seen as a work plan for your business-it gives you an idea of what you will spend and produce over a period of time in the future. A proper budget will include an educated estimate of what you will earn (income), and a precise plan for your expenses. Adhering to a budget successfully can ensure your business will be profitable and achieve its targets.
- For example, suppose your business is making plans for next year. A budget will outline your estimated revenue, then include a plan for spending less than income, so you can make a profit.
- A balanced budget means that the amount of income equals expenditure, a surplus means that income exceeds expenditure, and the meaning of a deficit is that expenditure exceeds income. As a business, your budget should always be in a state of surplus.
Step 2. Learn why budgeting is important
A well-structured budget is essential to business success because it will allow you to match what you spend with what you get. Without a clear plan for your expenses, your income will be easily eroded over time, which can eventually lead to losses, increased debt, and possible closure of your business.
- The budget will be a guide in every business spending. For example, if you realize midway through the year that your business really needs a newer computer, you can review your budget to see how much surplus revenue you expect to generate over the rest of the year. You can find out the cost of updating the computer and conclude whether it is still in surplus and allows you to make a profit, or alternatively, whether there is additional income to support taking out a loan for the computer.
- A budget can also help you figure out if you're spending too much, so you need to make savings mid-year.
Step 3. Identify each element of budgeting
According to the Small Business Administration, there are three elements of a business budget, namely sales (also known as revenue), total costs/expenses, and profit.
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Sale:
Sales refers to the amount of money your business makes from all sources. The budget will include an estimate or estimate of your future sales.
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Total Cost:
Total costs are the funds your business needs to generate sales. These include fixed costs (such as rent), variable costs (such as the materials used to make your product), and semi-variable costs (such as salaries).
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Profit:
Profit equals revenue minus total costs. Since profit is a business goal, your budget should include expenses that are low enough to allow you to get enough money back on your investment.
Part 2 of 3: Estimating Revenue
Step 1. Consider your current position
If your business has been in operation for several years, your revenue forecasting process will include revenue from previous years and make adjustments for the following year. If your business is just starting out with no business experience, you will need to estimate sales volume, price per product, and do some market research to see what you can expect from a business the size of your business.
- Keep in mind that revenue estimates are rarely accurate. The point is to give the most probable estimate with the knowledge you have.
- Always be conservative. That is, you should assume that you will get sales volume and price at the lowest possible range.
Step 2. Do market research to determine the price
This is especially important for new businesses. Look for businesses in your area that provide similar goods or services. Record the price of the product or service.
- For example, suppose you open a therapy practice. Therapists in your area may have a price range from Rp. 150,000, - to Rp. 500,000, - per hour. Compare your qualifications, experience and service offerings with those of your competitors, then estimate your prices. You may decide IDR 300,000 is a wise price.
- If you offer a variety of products and services, be sure to research competitors' prices.
Step 3. Estimate the sales volume
Sales volume is how many products you want to sell. Your income is the price of the goods/services multiplied by the number of goods or services you offer. Therefore, you need to estimate how many goods/services you sell during the year.
- Do you have customers or contracts waiting? If so, include it in the budget. Then you can assume referrals from customers and ads will add to this volume throughout the year.
- Compare with existing businesses. If you have colleagues who already have an established business, ask them what the volume was like in the early days of the business. For a therapy practice, your colleagues will probably tell you that during their freshman year, they got clients an average of 10 hours a week.
- Find out what drives sales volume. If you are going to open a therapy practice, for example, reputation, referrals, and advertising will invite people to come. Based on these sources, you may decide that one new client every two weeks is reasonable. Then, you can go ahead and estimate that each client will pay for one hour a week, and run for six months on average.
- Again, remember that revenue estimates are estimates only.
Step 4. Use past data
This is important if your business is already established. One effective strategy for making forecasts is to take the previous year's earnings and examine what changes will occur over the next year.
- Look at the price. Do you have reason to believe that your prices will increase or decrease?
- Look at the volume. Will more people buy your product or service? If your business has grown by 2% annually, you can assume the same thing next year if no significant changes occur. If you plan your ad aggressively, you can increase it to 3%.
- Look at the market. Is your market growing? For example, imagine that you run a coffee shop business in a downtown area. You may notice that the area is growing rapidly due to new people moving there. This can be a reason to add to your business growth forecast.
Part 3 of 3: Creating a Budget
Step 1. Get templates online
The best way to start budgeting is to get templates online. The template will contain all the available information, and your task will simply be to fill in the blanks with your estimates. This will save you from having to spend time creating complex spreadsheets.
- Call an accountant if you have trouble. Chartered Professional Accountants in the United Kingdom and Certified Public Accountants (CPAs) in the United States, as well as the Indonesian Institute of Accountants (AIA) in Indonesia are trained to advise businesses on budgeting, and for a fee, they can assist you in any aspect of the budgeting process.
- A simple online search for "business budget templates" can return thousands of results. You can even find templates that can be tailored to your specific business type.
Step 2. Determine your target profit margin
Profit margin equals revenue minus total expenses. For example, if your business is expected to generate $1,300,000,000 in sales, and the total expenses are $1,170,000, you will earn $130,000,000 in profit. This means the profit margin is 10%.
- Do some research online or ask a financial advisor what general margins should be for your type of business.
- If 10% is a common number for your business, you'll know that if the estimated revenue is $1,300,000,000, your expenses should be no more than $1,170,000,000.
Step 3. Determine the fixed costs
Fixed costs are costs that generally stay the same throughout the year, and they include things like rent, insurance, and building taxes.
- Add up all these costs to get an idea of the fixed costs for the following year.
- If there is past financial data, use the fixed costs and adjust them for rising rents, bills, or new fees.
Step 4. Estimate variable costs
The cost of raw materials and inventory to enable sales to occur is a key variable cost. For example, if your business is an auto dealership, the variable costs will include the inventory you buy and sell each year.
This number will vary depending on how much you sell, which is why it is known as variable cost. You can use your income forecast to determine this. For example, if you expect to sell 12 cars in your first year, your inventory cost will be the cost of buying 12 cars
Step 5. Estimate semi-variable costs
This is an expense that usually has a fixed element, but also varies depending on the activity. For example, telephone and internet data plans have a flat fee plus any excess usage. Salary is also one example. You may have estimated salaries for employees, but overtime or extra time caused by extra work can increase these costs.
Add up all the semi-variable costs that you have estimated
Step 6. Enter the three types of costs and make adjustments
After getting the amount for each cost type, add them all together. This will be your total cost for the year. Then you can ask yourself the core questions.
- Are your total costs less than revenue?
- Are your total costs providing a profit margin greater than or equal to your target?
- If the answer to both of these questions is no, you need to make savings. To do this, take a look at all your costs, and estimate what it could do without including them. Labor costs are one of the most flexible areas to save (although you risk upsetting your employees when their hours are cut). You can also look for locations with lower rental costs or reduced facility costs.
