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Step 1
1. THE BUDGET IS ALWAYS WRONG!
The first rule of budgeting is that the budget will always be wrong. Actual sales will never be exactly what you budgeted. Actual expenses will never be exactly what you budgeted. Sometimes the figures will be way out of balance. But don't let that be an excuse for avoiding a very worthwhile process.
There are several good software products out there that can make your task a lot easier. (Believe me, I've done it the hard way--before computers--too many times!) If you need help choosing one, ask your accountant to steer you in the right direction. Also, be sure to invest in software that will let you create charts and graphs of your financial progress.
(It's also useful to have the same software as your accountant or financial consultant. Come tax time, they'll appreciate your hassle-free downloads.) -
Step 2
2. SETTING UP THE BUDGET FORMAT
Have your company's most current financial statements available to help make sure that you're considering all items during the budgeting process. If you don't yet have financial statements, brainstorm. Try to think of any and all items that you will be budgeting for. Examples are travel, postage, salaries and wages, part time and full time temporary help, events for which you'll want a booth, client entertainment, and so on.
Create as many budget items as you wish and enter them in a vertical column at the left-hand side of your spreadsheet's page. Any old order will do until you find out just the right order for you. Some items will be subsets of larger categories that you can indent under a major heading.
Then label your time increments across the top of the page. Most small businesses divide their budgets into 12 monthly columns.
It is extremely useful to create a blank column beside each budget item. That way, as you progress through the year, you can fill in the actual monthly revenues and expenditures of your budget items and see just how far off base you were!
Or just how close you are to the figure you initially budgeted. Congratulations!
Now, link your figures to the chart or graph that your software will spit out for you, and you'll be able to generate visual aids that can help you spot trouble before it starts. -
Step 3
3. SALES AND OTHER REVENUES
Start the budgeting process with your sales or revenues. Enter your best projections, and don't forget to consider the seasonal implications of your business. For example, a retailer would consider holidays, especially major holidays, in trying to project sales. An accountant must consider deadlines such as income tax filings and the all-nighters that will be worth the revenues down the road!
The sales, or revenue, area is critical because the rest of your budget--costs, expenses, and capital expenditures--will be driven by your revenue estimates. Carefully consider the forces that could affect sales, but don't waste time worrying about what you can do to make your estimates "perfect"--because they never will be. -
Step 4
4. COSTS AND EXPENSES
Next, budget your costs and expenses. "Costs" are generally expenditures that can be easily tied to specific sales. In manufacturing, for example, costs would be the materials and labor that went into the products that were sold for the month. "Expenses" tend to be more general in nature and related to the conduct of the business. Some examples are office supplies, postage, telephone, or rent. If you work out of your home and can designate a specific area in your home that you use only for your business, you can deduct as much as 20% of the cost of your mortgage or rent, as well as 20% of your utility bills, from your personal income taxes.
Very Important: Keep track of the assumptions that you used to develop your revenues and expenses. That will help you remember the thought processes that you used to create the budget and will help you explain, to yourself and others, any significant variances in revenues or expenses from your initial budget. -
Step 5
5. THE OPERATING STATEMENT ("P & L")
Now, data for your operating statement, also known as your profit and loss statement (or P & L), are almost done. Sales minus costs and expenses equal pre-tax income or loss. If you have a profit and no tax loss carryforwards (ask your accountant what these are) from previous years, you must budget one additional expense--taxes. This can vary widely from state to state, so consult your accountant or tax advisor about what is usual in your state. -
Step 6
6. THE BALANCE SHEET
Now that you've finished your operating budget, it's on to the balance sheet. To start, estimate your accounts receivable, or the money that's owed to your company for its* products or services. My accountant recommends the "days sales outstanding" (DSO) method. For example, if you estimate that you can collect an average customer invoice in 45 days, then the accounts receivable budget at the end of the month will be equal to sales for that month plus one-half of the sales of the previous month plus one-half of the sales of the month before that.
If you have inventory or product-related expenses that were not included (or "expensed") in the operating statement, you'll have to estimate them for the balance sheet budget.
Capital expenditures must be budgeted and added to the "fixed assets" or previously purchased items that appear on the balance sheet. (Incidentally, any changes to fixed assets will also affect the depreciation expense item that should appear on the operating statement.) -
Step 7
7. ACCOUNTS PAYABLE
Accounts payable are usually a significant liability item for a business at any point in time. Budget your accounts payable based on your closest guestimate of your own or similar businesses'* historical payment practices, adjusted for any major changes in the volume of purchases.
Other items should be budgeted as appropriate. As I mentioned earlier, use your most recent financial statement as a guide. -
Step 8
8. PLANNING FOR CASH
For many businesses, especially smaller ones, the most important result of the budgeting process is the "cash position" or "cash required" figure. It tells you whether or not, based on your assumptions, you will have enough cash to operate your business. If not, you'll have some time to plan alternative revenue strategies.
In the balance sheet, the cash position or cash required is usually the balancing item on the balance sheet.
If you want a more detailed understanding of your cash position, you can prepare a cash flow or "sources and uses of funds" statement as part of your financial statement package and budget. Several forms are commonly used. Your accountant can help you find the right forms for you. -
Step 9
9. CREATE A PERSONAL BUDGET
While you're at it, consider creating your personal budget as well. You'll never be as close as you are to writing an informed personal budget as when you've completed your business's** budget. (Hey, if nothing else, it can help you validate the enormous salary that you've found you really can afford!)
After all, family finances can be nearly as complicated, if not more so, than those of many small businesses. And many of the same principles and mechanics apply.
There are computer software packages that will automatically track both business and family finances and transfer relevant income and expenditures, making it easy to see at a glance where you are at any point in time with both. You will also be able to see easily what your tax liabilities will be for both personal and business finances.
If you're already budgeting, you know the benefits. If not, try it. I think you'll end up wondering how anyone can manage a business without it.
