Building a Small Business Budget
- Posted by Justin on 08.04.2007
When you start a Central Coast small business, preparing a budget, without any history on which to base your estimates, is a daunting task. You may have some idea of what you hope to earn and how much it will cost you to earn it. You can make broad estimates of income and expenses and may get your budget done quickly, but this won’t give you a tool to guage your performance and manage your Central Coast business. It is better to start at the bottom and build up.
First of all, do I really need a budget?
In short, yes. A well-run household operates on a budget, even though it may not be written down. You are in business to make money - all the more reason to have a budget showing how you will do just that. A budget is an extension of your business plan and strategy, put into practice. It serves to quantify the plan in financial terms, and lends a sense of reality to conceptual ideas, transforming them into a feasible business endeavor. A well-prepared budget will serve as a baseline and an important reference point to guide your business in the right direction by providing an essential framework for the start-up and initial operating stages. In this sense, it is a very important tool in managing the Central Coast business, provided the budget is based on realistic data that can be used to gauge actual performance.
Having a detailed budget will also be a distinct advantage when dealing with potential lenders and investors. It will give them a clear idea of what your Central Coast business is about; how you intend to carry out the business plan, in concrete, financial terms; what the loan or investment is needed for; and how the money will be spent. A good budget will show a lender how the loan will be repaid, and will show an investor what type of return can be expected on the investment. In both cases, the budget will significantly improve your chances of getting the financing you need for the business. And if you have sufficient depth and detail built into your budget, it will be much more credible to lenders and investors.
Even though a budget is an estimate, or a projection of future events, it should be based as much as possible on actual data obtained by doing research, getting quotes, and assembling and organising documentation and information. The idea behind building a budget from the bottom up is to start with what you know, or what you can find out. Starting at the bottom means going to the lowest level of detail, where you have building blocks – concrete pieces of information that can be put together to construct the various different line items such as revenues, cost of sales, advertising, rent, maintenance, utilities, and other overhead expenses. These building blocks are basically quantities, hours, prices and rates. Rather than budgeting total income and expenses as a certain amount per month, for example, you can break these figures down into their component parts.
The operating budget should be structured based on the way the Central Coast business operates. Revenues and expenses should be budgeted at the same level of detail as they will be recorded for actual operations. This provides you with a tool for managing your business. A sufficiently detailed budget will enable you to compare actual results with budgeted amounts and perform quantity and price variance analysis.
Product recipes for budgeting cost of sales
If your Central Coast business involves selling a product, you may start by determining what it will take to make the product, in terms of materials and supplies, labor, and overhead. If you can prepare a "recipe" for a product, and identify the ingredients, you can do some calculations based on quanitities and prices to figure how much it will cost to make each unit of product. The ingredients include direct costs of raw materials, supplies, and labor.
If you want to determine an "all-in" cost, you will need to add in the indirect costs or overhead expenses, such as indirect labor (administrative and management, for example), utilities, maintenance, depreciation, insurance, and any other general expenses. Based on availability of time and materials, and your production capacity, you can determine how many units you are able to produce each month. If you know what your average monthly overhead expenses are, you can allocate the overhead over the number of units to determine how much should be added to the cost of each unit. If you are making more than one product, you may want to assign a weighting factor in allocating overhead expenses. For example, products with a higher direct cost would absorb more of the indirect costs.
One way to budget revenues is to take the budgeted cost of sales and add a profit margin. The unit cost of each product plus your expected profit margin would give you a budgeted sales price. In this case, you should use the "all-in" cost, to ensure that your selling price is sufficient to cover all your costs and still leave you with a margin. Budgeted revenue would then be the quantity of units times the budgeted selling prices.
But there are market forces that should also be taken into consideration, that may affect the price you can reasonably expect to charge in order to be competitive in the marketplace. In preparing the budget for revenue, you may want to collect information on competitors’ prices. Since you are most likely starting a Central Coast business in which you already have knowledge and expertise, you may be well aware of these market factors. The important aspect in budgeting is to try to quantify these aspects and incorporate them into budgeted selling prices, and budgeted revenue.
If you are introducing a new product, you may be able to budget revenue based on prices for similar products, adding an incremental amount based on the expected added value of your product. If you have done a market study, this information will be valuable in building the budget.
If you are in the service business, your inventory is your time. The building blocks for budgeting rervenue in this case are the number of billable hours available, and the rate to be charged per hour. Hours and rates should be broken down by person, if the business involves different persons performing different functions.
Billable rates may vary, depending on the person’s qualifications and experience. And billable hours may vary depending on the person’s functions. A person dedicated almost entirely to customer service will have a different number of billable hours than a person who primarily performs administrative and support functions. The nonbillable hours may be factored into the billable hours, by incrementing the billing rate to be charged. Or the nonbillable hours may be left out and absorbed as overhead within the operating expenses.
Here again, market dynamics will need to be taken into consideration. But you can reasonably estimate your revenue by determining your billable hours per month times the rate you expect to charge.
Jobs or projects
If your Central Coast business involves jobs or projects, budgeting will probably include aspects of both product and service revenue budgeting. Based on your line of business, you will know what is involved in completing the job or project. The work may involve materials and supplies, direct and indirect labor, use of equipment, and maybe subcontractors. Budgeting for jobs or projects may go hand-in-hand with submitting job estimates or bids. The terms and conditions of the work will play an important role in how the work is quoted or budgeted. A lump sum contract for a particular job is different from a fixed rate contract, for instance.
Breaking down the job into its component parts will be a key factor in submitting a good quote or bid, and budgeting job costs and revenues. You will want to make sure you have all your bases covered, in the sense that you include all your costs, both direct and indirect, and allow yourself a sufficient margin. You may need to make out a materials list, a job schedule for direct labor, and an allocation calculation to include indirect expenses. If you are going to use subcontractors, you should get bids from them, hopefully before committing yourself to the job.
If your business involves jobs that extend over a longer period of time, first you will want to make sure the amount you are charging for the job is sufficient to cover all your expenses and leave you with a margin that gives you an adequate monthly income during the period you are working on the job. You can budget monthly revenue and cost by spreading the total job over the months of work.
If you are working on several jobs at a time, you can use your timelines for each job, and then allocate the total revenues and costs for all the jobs over the applicable periods in order to come up a monthly budget.