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Starting a business of your own is one of the most rewarding things a person can do and is an aspiration countless people have. Aside from the basic skills that go into the daily operations of an entrepreneurial initiative, a sound financial understanding is crucial for long-term success. No matter how good your product or service is, how diligent you are, or how talented you are at marketing, success will prove elusive if you don't have a solid financial plan.
An essential element of sound money management is budgeting. Budgeting is one of the fundamental activities that go into effective business management. As an entrepreneur, you will be able to determine whether or not you have sufficient sales volume and capital to fund your operations, expand your venture, and, ultimately, generate the profits you desire.
Developing a workable budget may seem like a daunting task, but it is very feasible once you understand the basic steps that go into the process. In this piece, we'll look at the fundamental steps you can take to formulate an effective budget for your new business. You don't need to have a business degree to make this work - we'll avoid the jargon and keep it straightforward. If you have the nerve and initiative to venture into the world of self-employment, you're already a star. Here's how you can develop a budget that will boost the odds of business success in your favor.
Let's get right to it.
1. Study Your Industry
You don't need to reinvent the wheel. In business, as in life, it is always easier to learn from the mistakes of others than to do things the hard way by making some of your own. Of course, not all businesses will be alike in all their particulars, but there are many parallels that you can learn from. Learning about what others in the industry of your choosing are doing and how they are doing it will give you a significant head start.
Make use of the internet, talk to local small business owners, and develop a general idea of what it will cost to maintain an operation of the scale you envision. The internet will be an especially valuable resource for you at this stage. Learn not only about what works but what doesn't as well.
With a solid grasp of the industry standards in your chosen niche, you can then proceed to develop a game plan that suits you and optimizes your probabilities. Do not, however, delve too deeply into the details of any relevant case studies - the fact is that the rates of volatility experienced by small businesses are much higher than those encountered by larger, established, and diversified organizations. Note the general conditions and draw correlations that you feel will have an impact on your operation. You will now be at the point where you can settle down and draw out a functional, realistic budget.
2. Detail Your Income Trends
Set down all the sources of income that your business has, preferably every month, going back at least twelve months if possible. A year is a good scale here because many businesses have seasonal ups and downs, with some months experiencing an uptick in revenue and others experiencing downturns (keeping in mind 2020/2021 are anomalies for many businesses). Identifying these trends will allow you to make allowances and preparations for these changes and ensure you're not caught in a tight spot unaware.
3. Outline Your Costs
Once you know your revenue, you will need to determine what your costs are in detail. Spreadsheets are excellent tools for these kinds of exercises. Costs might be classed into various categories and rankings depending on what type of enterprise you are engaged in. Still, some of the general cost groupings include rent, taxes, insurance, debt service, supplies, and payroll. These are considered fixed costs since they are more or less constant throughout the life of your business.
There will be other, non-fixed costs, as we'll see as we move on, but the key point here will be to make as accurate a picture as you can manage. While revenue might be a relatively difficult metric to estimate, your fixed costs will remain somewhat constant. They will need to be taken care of if your small business is to remain operational and flourishing.
4. Determine Your Variable Expenditure
Now, aside from the fixed costs you will incur in your business, there will be other expenditures that we refer to as variable costs. These types of costs will change depending on various circumstances, such as how much you use them, with utilities such as power and water being good examples. Other variable expenses might include your salary, office supplies, raw materials, marketing expenditure, equipment replacement, professional development (education and training), and more.
Professional development and education might not be essential to the current operation of your business but have a high likelihood of increasing your business success in the future, which is why they are often referred to as discretionary expenditures. Having a sound knowledge of your variable expenses will serve an important purpose for you as you draw up your budget - it will allow you to determine where and how you can cut or minimize costs during low revenue periods. Having a picture of your yearly revenue trends will allow you to identify the months you need to tighten your belt.
A useful method of ensuring financial stability across the life of your business is to have some slack factored into your budget projections. Unexpected costs or disruptions to your business operations will be weathered much more comfortably if you have a certain amount of money stashed away. It is also important to have enough money set aside before contemplating any expansion initiatives or taking in additional employees.
5. Draw Up a Profit and Loss Statement
At the heart of your budget will be your profit and loss statement - your P&L for short. This might seem like the most challenging bit, but if you've followed the steps we've covered above, you'll have already completed 90% of the work. Also known as an income statement, the P&L statement will serve as a historical document that shows your business's financial history, and the relevance of this is that it will allow you to make informed estimates concerning what your roadmap for the future is.
Businesses big and small all engage in the practice of trying to estimate what their future conditions will be, and budgeting is simply a way by which we try to make our guesses as accurate as they can be. Take the time to analyze and understand the information that your P&L statement will offer you. Spot the trends that appear and understand the causes behind them. This is at the heart of budget planning and what makes it a powerful tool for the forward-thinking business operator.
6. Create a Cash Flow Statement
In addition to your P&L, you may want to generate a cash flow (CFS) statement. This is a financial document that lists your net income and details your company's cash inflows and outflows within a specified period of time. Your cash flow statement and P&L statement, along with a balance sheet, are the three most important financial documents for managing your business finances and making sure you have enough money to stay afloat.
Any money that your business takes in or spends is listed in the CFS. Typically, this includes operating, investing, and financial activities. Operating activities detail the cash inflows and outflows from the daily activities of the company, including both revenue and expenses. Investing activities lay out any changes your company has experienced in investment gains and losses, and financing activities refer to cash earned or spent from financing your company, such as taking a business loan from a bank.
Cash flow statements are essential to your business plan for a few reasons. First, they allow you to view your liquidity, that is, how much cash you have on hand to fund your operating expenses. Second, they detail all of the changes in your assets, liabilities, and equity, which are crucial for your business accounting. But perhaps most importantly, a CFS allows you to predict how much cash flow you can expect to have in the future, enabling you to make better financial decisions.
7. Make Regular Reviews and Updates
A budget is a living document that is subject to constant updating as your business continues to operate and grow from month to month and year to year. Regularly updating your statements is the most effective way by which you can monitor the financial health of your enterprise. It is all too common for small businesses and startups to fail when owners, with all their attention focused on the money coming in, fail to notice that more money is going out. To maximize the efficiency, accuracy, and effectiveness of your budget, there are a few measures you can take:
Invest in some of the accounting software packages available to you. Quickbooks is one popular example of bookkeeping software that makes the task of keeping track of your finances convenient and effective. Ask around and find out what type of software will suit your business needs, depending on the type and scale of your business and your comfort level with computer technology.
8. Increase Your Efficiency
You have the option of hiring a professional accountant or bookkeeper to provide guidance and assistance to you while developing and managing your budget. They will be in a good position to help you keep on track towards your objectives and steer you well clear of potentially costly pitfalls such as tax violations.
Make your budgeting process a manageable one by doing it in small parts at a time. Set aside time each day or each week to note your progress, being sure that you capture all the inflows and outflows of money your business experiences. It's always a good idea to develop a filing system that will allow you to locate any information you might need quickly and accurately, whether it is in the form of computer documentation or paper filing.
As they say, failing to plan is planning to fail. Developing a budget is one of the most useful measures you can take to avoid financial distress and maximize your odds for success. You might have been operating without a clear budget to guide you so far and might even be managing successfully, but in truth, you will probably find yourself making much more progress and profits once you take the time to set out a proper budget.