A hiker trekking through the wilderness wouldn’t start his trip without a map and compass. After all, those small tools are a big help in getting to the end of the trail. Yet too often, small-business owners set up shop without a financial road map. One of the easiest ways to get where you want to go is to create a budget and sales forecast.
Try not to think of a budget as a belt-tightening diet that forces you to cut costs and deprive yourself, says Pam Newman, author of the management accounting guide Out of the Red and president of the small-business consulting firm RPPC Inc. “A budget should be a guide, not a constraint. A reasonable budget allows you to use your resources where they’re most needed,” she says. By creating a financial plan, you control your business’s cash flow instead of it controlling you.
Creating a budget doesn’t have to be complicated or time-consuming. The key is to determine how much you’ll spend and earn in the next year, then use those figures to project how you want to grow your business in the future.
If you already own a business, dig through some records to see where your money went, then decide where you actually want it to go. If you’re a new entrepreneur, do some homework — and make realistic assumptions about your business. To get started, Newman recommends answering the following questions:
- How much can you realistically sell next year?
- How much will you charge for your product?
- How much will it cost to produce it?
- How much are your operating expenses?
- Do you need to hire employees? If so, how many, and how much will you pay them?
- How much will you pay yourself?
- How much payroll and unemployment taxes will you pay?
- How much money do you need to borrow, and how much will your monthly loan payments be?
The answers to these questions will form the basis of your budget and forecast, and they will help you determine two essential things: your projected income and expenses.
In the income category, conservatively estimate how much sales revenue you’ll have next year. Extrapolate and forecast based on what you made last year. For new business owners, try to determine how much your competitors gross, and use those figures as a guide. Remember to be realistic. If you paint too rosy a picture, you can easily get in over your head and spend income that never materializes.
When it comes to expenses, consider advertising, transportation, insurance, rent, taxes, phone, utilities, equipment, and payroll. In short, include any and all business expenses, whether you pay them now or expect to incur them in the future. Much as personal finance experts recommend people set aside an emergency fund of three to six months of monthly income for worst-case scenarios, small business owners should follow the same route, setting aside six months of expenses in case sales are slow.
Once you see your projected income and expenses on paper, you’ll know exactly how much you need to bring in every month to keep things afloat, and how much cash you’ll have left over. That makes it much less tempting to spend money on business expenses that aren’t part of your plan. And that’s really what a budget is for — to ensure your expenses aren’t more than your income, so that you can keep your company afloat heading into 2012 — and the years to come.