Small Business Budgeting | Reasons and Examples

0:28

First question I'd like to answer is, why budget? Budgeting can take some time, it can be complex. So the reason you want to budget for your business.

First, it's a financial control. Unlike your personal life, where you can kind of look at your bank balance and say I'm okay, you've got a lot of money coming and going and it's really easy to spend more than you should be with the cash flow cycles of a business. So as a financial control, that helps you to control expenses. It helps you plan for things like hiring, that can be very cost consuming for your business.

It is also a way to cash flow plan. So as you budget out what your income and your expenses are, you can quickly turn that into a cash flow model that'll allow you to know if you need financing, and when.

Most importantly, budgeting empowers you to ensure profit. It is a financial model. It should reflect your financial model, and you should be constantly tweaking your budget as you better understand your financial model, so you can ensure profits throughout the year, or at the end of the year at least.

So I have a question for you that I'd love to hear from in the comments. What are you looking to achieve with your business budgeting?

1:52 Use a spreadsheet

Now let's talk about tools to get started with budgeting.

There are a lot of third-party tools that you could use to build a budget. I'm not going to start there. I'm going to recommend, if you're getting started with business budgeting, to use a spreadsheet. Everybody has a spreadsheet. They provide a lot of flexibility for modeling the nuances of a business's finances, and they're easy to change. So pull out that spreadsheet, whether it's Excel or Google Sheets, and start there.

2:20 Choosing your time frame

So let's talk about how you create your small business budget.

First thing you have to decide upon is time frames. You could look at weekly, you could look at monthly, you could look at quarterly. Most businesses are going to want to use a monthly time frame to measure and create the model for their budget.

Usually a month is adequate to handle cash flow. Sometimes you have to get into weekly modeling for cash flow, but a month at a time is good for most businesses. It also aligns nicely with your accounting software, so you can run your monthly profit and loss statements and compare that to your budget. And so I would say, if you're getting started, for most people start with a monthly time frame.

3:06 Structuring the budget and choosing a basis

Next you have to think about the structure of your budget. Typically what I like to do is structure budgets to reflect the profit and loss statement. That way you can easily compare actual expenses and income to your budgeted expenses and income.

I will break things out into separate worksheets and roll them up into a summary profit and loss budget model. So I'll break out my expenses, my income, my cost of goods sold. And as I need to, I'll break out individual line items into separate worksheets, and that way I can simplify the structure of my book and make it cleaner to manage.

Now in terms of getting started, the easiest thing to do is to go and look at your past financials. You could either look at the previous month or the previous year, which will allow you to see the seasonality of income and expenses, and then you apply the appropriate growth factors to those previous spend amounts. This is a simple way to get started. It may not be the most accurate, but it's better to get started and then understand why you're off.

4:21

The final thing you have to think about when you're modeling your budget is whether you're going to use cash basis or accrual basis.

Now if you don't know what these mean, use cash. But if you do, accrual can make sense at times. Cash basis is easier to turn into a cash flow model. A lot of small businesses are going to be starting with cash basis accounting, so if this is your first budget, cash basis budgeting is probably more than adequate for what you need.

4:48 Building it out

So now let's build out your budget.

What you're going to want to do is you're going to start with sales. You're going to model your different income streams, again by month, and do your best attempt to forecast what's going to happen. This is really critical, and it's also a dark art, because it's really hard to forecast your sales.

Second, you're going to look at your cost of goods sold. Cost of goods sold as a percentage of income should be fairly fixed. So whether it's forty percent or sixty percent, or heaven forbid 80% of income, as you're modeling it out, a way to check to see if it's right is to kind of look and see if that ratio, COGS as a ratio of income, is fairly standard. If you go back and look at your financials you should see this. If you don't see this, you're probably not doing it right, but it should be fairly fixed as a percentage.

5:47

Third, you're going to want to model your expenses. Like I said, I like to mirror my profit and loss statement, so I have a line item for every line item that I have in my profit and loss. And if needs be, I will break out that line item into a separate worksheet.

One example is payroll. Payroll can be very complex when you have people coming and going. You might have a hiring plan or a seasonal employment plan, and so payroll is almost always the first line item that I break out into a separate worksheet and model out the expenses there. And so in that model, I'll take complex line items, break them out into separate worksheets, and model them accordingly.

6:29 Budget versus actuals

So finally, you've put in all this work to build your budget. Now what? Well, you need to use it.

You need to compare the results of your business against your budget monthly. So in finance terms it's called budget versus actuals. What did you budget versus what actually happened. There's always going to be differences, and so you need to learn from those differences.

Was your sales or income lower or higher than expected? Why was that the case, and do you need to make adjustments accordingly? Often certain expenses will go up with sales. Obviously your cost of goods sold will go up with sales, and so you need to be paying attention to those.

You probably want to look at some of those key ratios, like what was your gross margin, which is the sales minus cost of goods as a percentage of income. It's a little bit of a math equation, but you do those income ratios. So what was my gross profit ratio, also known as gross margin. Look at your expense ratios on key categories, and you want to see that those hold steady month after month, even if your budget or your actuals fluctuate some.

7:46 Controls and adjustments

The one thing you can control more than anything is your spending. And so if you find that you're not staying in line with your expenses in particular, you need to put in controls. Whether it's limits on credit card spending, whether it's pre-approving spending, whether it's using purchase orders, there's a number of financial techniques that you can use to review a spend before it occurs. So if you're finding that your expenses are not staying in check with your budget, then look at applying additional controls.

Now thirdly, as I mentioned, you're not going to have a perfect alignment between what actually happens and what you budget. So you need to adjust your budget periodically. I would say most businesses are going to have to do at least a mid-year adjustment, because usually your sales will be off, either in a positive way or a negative way, and you want to adjust that forecast and probably how you're going to spend accordingly.

Again, your goal should be generating good profits. So if you're generating more sales you're probably going to spend more, but you want to make sure that that is done profitably. Likewise, if your sales are down you want to make sure that your expenses are down, to allow you to generate the profits that are appropriate for your business.

If you found this video to be helpful, I'd love to hear your comments, your questions, your thoughts. Like it, share it, and subscribe to our channel. And finally, if you need help with budgeting, reach out to LedgerGurus. We'd be happy to help you with your budgeting and accounting needs.