It’s no secret that financials can be a bit daunting. So if you an aspiring entrepreneur who needs some help with preparing a budget – you are in the right place.
Why do we need a budget?
We believe that financial planning is a key skill of a successful entrepreneur.
First, it helps to stay on top of your business goals and achieve desired sales and profit targets.
Second, it enables you to plan your expenses, prioritize allocation of funds, and make timely adjustments.
Financial planning is a process that involves:
- Preparation – planning for a year and preparing a budget, considering what needs to be achieved and what resources we need
- Monitoring – reviewing performance and comparing actual performance against budgeted performance
- Controlling – observing if there are any variances, and then taking actions to stay on track to the target
A budget is a financial planning tool that helps to forecast and plan your sales, expenses, and, finally, a profit of your start-up. It can assist you and your investors to evaluate whether you business idea is viable.
Types of budgets and how to prepare your first budget
- Business budgets can be prepared on a monthly, quarterly or yearly basis
- Your business needs two types of budgets: a budget focused on profitability and a budget focused on cash flow
When your company is a start-up, you will start with a zero-based budget. It means that all your expenses and sales figures will be based on your estimates.
Accuracy of your estimates will depend on how detailed the industry research is. Your research will include finding the prices your competitors charge, estimating salaries and payroll, inquiring about rent charges, and obtaining quotations from utility companies and insurance providers.
Once you start trading, your next budgets will be based on the historical financial performance of your business with some adjustments depending on different factors, such as inflation, competition in your industry, general economic situation, or other factors that can impact your sales and expenses.
To create your first budget, you can use a spreadsheet or accounting program.
You need to include in your budget: projected sales, fixed expenses or overheads and variable expenses that change with your sales. Fixed expenses are not directly linked to sales and unit production.
Operating budget enables to evaluate profitability of your business and to plan your revenue and expenses.
When estimating your revenue, think about how it will grow and what additional expenses will be incurred to support this growth, for example, hiring an additional staff member.
To get a realistic estimate of revenue, research what the average revenue figures are in your industry.
If you are buying an existing business, you can ask the owner about their average sales figures.
You also need to have a clear understanding of how your direct sales and marketing activities will impact on your sales. In other words, how many leads each activity can bring and what your conversion rate is.
The other factors that can impact your sales are repeated business and seasonality.
Finally, your sales forecasts can be based on different product groups or regions so you can efficiently allocate funds and maximize your opportunities.
There are two types of expenses:
o Fixed expenses or overheads: rent, insurance, personnel including payroll, sales and marketing, utilities and services (phone, internet), repairs and maintenance, legal and accounting, fees and licenses, interest, depreciation
o Variable costs: costs of goods sold, such as costs to produce the products, labor cost, materials, delivery, storage, packaging, and any expenses that you make to produce a unit of your product
To estimate variable costs, you can speak to indirect competitors.
We recommend preparing three different scenarios of sales projections: worst-case, best-case and realistic-case. Your fixed costs will stay the same, but your variable costs will change with sales.
By doing three predictions, you can see how fixed costs can impact your business and where you break-even.
Example of a monthly operating budget
|B. Cost of goods sold||£30,000 (30%)||£50,000 (38%)||-20,000|
|C. Gross profit (A – B)||£70,000 (70%)||£80,000 (62%)||10,000|
|D. Total fixed costs||£31,600||£35,000||-3,400|
|Net profit (C – D)||£38,400 (38%)||£45,000 (35%)||6,600|
|If sales or gross/net profit is less than budget, the variance is negative. If costs or overheads are less than budget, the variance is positive.Taxes are not included in this budget.|
As from this example, you can see that the actual performance is better than the budget, as the gross and net profits are higher than projected.
However, you should be careful in watching for costs as they impact the net profit. This is why the ratio of the actual net profit is lower.
Cash flow budget
Cash flow budget allows to project cash inflow in the company and to predict how your business can pay the bills.
Using your operational budget you can forecast cash inflow and when you are able pay your bills.
Suppose, you will collect cash from your sales in 30-60 days and you have immediate bills to pay now. Ideally, the sales from the preceding month should cover the current month’s bills.
Knowing how much cash you need every month to pay the bills can help you to stay out of the red zone.
Your budget is a living document and you need to check it against the actual performance of your business and make necessary changes.
You can compare differences between the actual and forecasted income and expenses on a monthly basis. If your profits are lower than expected, than you can either adjust your prices, find other supplier who can offer you better prices, or even cut some of the nonessential expenses.
Your budget can be adjusted as based on your predictions of how the variance between the actual and projected performance would change. The more experience and insight you have about your business, the more accurate your budget estimates will be.
We hope you are now equipped with some basic and important knowledge to prepare your first budget, and if you have any questions or need any help, do get in touch.
For more information about any of the above or to enquire about our business plan writing service do get in touch.