Of all of the exciting things that come with running your own your business, setting an annual budget is rarely near the top of anyone’s list. In fact, many entrepreneurs never get around to it, or do a half-hearted job, as they get caught up in the excitement of pursuing their dream. But those who don’t are making a big mistake, one that can make the difference between survival and failure, particularly in today’s challenging economic climate. Fortunately though, while setting a budget will never be the most thrilling part of being an entrepreneur, it can be a relatively painless one.
In order to create a budget you’ll probably want to use QuickBooks or some other accounting software, and you should actually produce two types of budgets: an operating budget and a cash-flow budget. This week we’ll focus on the operating budget, which can then be used as a template to construct the cash-flow-budget.
The operating budget should list all of your projected revenues and expenses for a one-year period. It can be helpful to start with the expenses, as they are usually easier to quantify. Begin with your fixed costs, like rent and insurance, which are unlikely to change throughout the year, and then move on to include your best assumptions for variable costs such as marketing and travel expenses. Make sure to include everything that you will need to spend money on to keep your business running, down to the smallest expense.
The next step is to tackle the revenue side of the budget, and the most important thing here is to be realistic. This means that if you’re just starting out you shouldn’t assume that you’re going to hit the ball out of the park right away, and if you’ve been at it for a while you shouldn’t be projecting that you’re going to enter into a high-growth phase all of a sudden.
In forecasting both the revenue and expense sides of your operating budget, flexibility is the key to coming up with a set of numbers that are likely to provide an accurate guide to how your business will actually perform. This means that you should produce three different operating budgets: one that reflects a best-case scenario, one that reflects worst-case, and one that straddles the line between the two. (Don’t worry, once you’ve created a budget with one set of numbers, it’s really easy to tweak to examine other scenarios.)
Constructing multiple budgets in this way can be a huge help in seeing how changes in key metrics from employee compensation to the price you charge for your products can affect your bottom line.
Once you’ve completed your operating budget you’ll have a set of projections not just for your total revenues and expenses for the coming year, but a predictor of the amount of profit or loss that you’re likely to earn under each of your three scenarios. Of course, if you just file the budget away and forget about it until next year it’s not going to do you all that much good. Instead, make sure to review the budget on a regular basis—at least quarterly and ideally monthly—to see how your business is tracking and to make adjustments if necessary.
While a well-constructed operating budget can help you manage your profitability, it won’t tell you much about your business’s lifeline: its cash flow. So next week we’ll explore how to create a cash-flow budget that does just that.