Budgeting, whether for the home or the business, is a management tool for dealing with the future. It helps you turn expectations into reality. More often than not, homeowners, and businesses, don’t prepare an annual budget; and often wonder why reality does not meet their expectations.
As homeowners and businesses work into a new year, a review of budgets and budgeting is appropriate. Let’s illustrate some of the basic principles of budgeting for the small business.
My Teaching Lesson
Some years ago when I was instructing a group of graduate students in the foundations of financial administration (yes, it did seem boring to some), several students approached me and wondered when I was going to teach them “Budgeting 101.” How did they get this far in life, I wondered, without knowing how to budget?
We took several lunch hours over the blackboard (yes, they were still in use then) to develop a real budget. So I asked them some very sophisticated questions – Do you have a checking account, a savings account? What do you use your checking account for – daily, weekly, monthly expenses and bills. What do you use your savings account for – major house repairs, major purchases, and, oh yes, saving for the future.
It did not take long for my charges to get the message – add up all your weekly expenses, month by month for the past year. You will see a pattern of expenses – cable bill, electric, gas/oil, water/sewer – your utilities, groceries, clothing, supplies, insurances, etc.
Now that you know what you have spent on regular, recurring items, when do your “discretionary” expenses occur? Why do you decide to purchase them? How are they related to your family needs, your lifestyle needs, and your “splurge” needs?
Once you can answer these questions, you know several things – how much you need in “take-home pay” to pay for these expenses on a monthly basis, as well as the motivations behind your spending patterns. You may also then have the ability to make some choices on those discretionary items (change your priorities), or lower the thermostat, water the lawn less, or become more of a coupon shopper.
And if you can lower your payments and/or increase your take home pay, you can leave more in the bank!
One of my students acknowledged he finally understood all about budgeting! And I did not even relate it to business. Oh well, perhaps in retrospect the class was boring.
For business, budgeting is not very different. As businesses begin to wind down their fiscal year, their first consideration for the next year should be about the prospect of increasing their profit for their business. Working up a budget helps them to determine whether their profit goal is within reach.
First Steps – Collecting Data
So, let’s get started. Collect all your fixed costs and your variable costs for the past year.
Regardless of sales, fixed costs stay the same. Several examples of fixed expenses are insurance, rent, taxes on property, wages paid to salaried employees, depreciation of equipment, interest on borrowed money, building maintenance costs, office salaries, and office expenses.
Variable costs vary with sales. In some businesses, the cost of labor is the biggest factor. Sales commissions, payroll taxes, insurance, advertising, and delivery expenses are other examples of variable expenses.
Break them out and organize them on a monthly basis – November through October. Next, we will look at how these fixed and variable costs can create a budget, and, more importantly, lead to the creation of a more profitable business.
Analyzing Your Data, Making Some Assumptions
In the last step we asked business owners to pull together a full year’s fixed and variable costs/expenses so that we could begin to create budget and create a more profitable business. From these three figures – profit, fixed expenses, and variable expenses – you can determine your “hoped for” total income.
When the figures are all together, you have answers to questions such as: What sales will I need to achieve the desired profit? What fixed expenses will be necessary to support these sales? What variable expense will be incurred in producing the product or services?
Because business is not a cut-and-dried affair, the first budget often will uncover issues and suggest choices to you. Working up alternative budgets will help you decide what changes you will need to consider in order to have a workable plan for next year.