Budgeting for small business owners

Basic Budgeting as a Management Tool
“Think of a budget as your roadmap,” says Pam Newman, President of small business consulting firm RPPC, Inc., and author of Out of the Red: Management Accounting Concepts to Keep Small Businesses Out of the Red. “If you’re planning for the upcoming year, the budget will help you set expectations and account for potential shortfalls and the impacts of unexpected opportunities. Once you’ve created your budget, it shouldn’t be written in stone, but updated on a regular basis so that you can make the most of it.” A basic budget is just that; a simple document that outlines three key areas of your business: sales, expenses and profit.
On the sales side, it’s all the revenues you generate through the sales of your product or services.
Expenses are twofold, encompassing direct costs and indirect costs, or overhead. “Direct costs are those that include the materials and labor needed to create your product,” Newman says. “If you’re a shoe-maker, for example, it’s the leather, laces and people that put the shoes together. The indirect costs are your rent, marketing, insurance, utilities or any other expenses not directly related to manufacturing or creation of your products and services.”
Profit is broken down into two buckets as well. Gross profits are your sales minus your direct costs, which gives you what you need to cover overhead. What’s left after you take the indirect costs out is your net profit or loss.
Regarding the last point, Newman adds that, “It’s critical that you consistently measure the difference between your gross and net profits. If, for example, your gross is positive and your net is negative, it may mean that you’re not managing overhead well or that you’re not marking up your products and services appropriately. It’s not unusual for business owners to set prices using direct costs, but you can lose sight of those indirect costs. A couple hundred dollars a month here or there really adds up and depletes profits, which is why consistent budget review makes such a difference. It helps you spot those patterns and make changes to correct your course.”
As far as review is concerned, Newman recommends that the budget be assessed at least once a month, calling it a “living document.” In addition, columns should be created for your projected numbers vs. actuals each month. If you’re not on target, you need to know why. The budget allows you to develop a history for your business, and can also help you understand where you need to make changes going forward. If your sales are double what you expected in a given month, it may indicate that your business is growing faster than you may have thought. That may be a signal that you need to think about putting more resources into product development, adding more space, hiring or other areas, which then affects those related budget areas.
The budget is also an excellent expense-management tool. “In general, you know where your expenses are, but often, you have the opportunity to do something that makes a difference for your business, like a spot inventory purchase or in marketing through a special advertising buy,” says Newman. “The budget can show you where you can make moves to support that unexpected expense—where you might put off an expected purchase to account for this opportunity.”
Newman acknowledges that creating and monitoring a budget can be daunting for anyone without a finance or accounting background. “You may want to sit down with an accountant, financial manager or bookkeeper to set up your initial budget,” she notes. “Once you feel comfortable with the process, take it over yourself. After you’ve created and worked with your budget, you’ll find you have a document that can help you succeed throughout the life of your business.”