Budget Basics

Preparing a Budget

The most common budget period is one year, but this can vary depending on whether or not your business has seasonal or cyclical fluctuations.

The budgeting process usually begins with the collection of accounting data. In order to prepare a strong and achievable budget, you must analyze each item of income and expense from the prior year. If your accounting system is a mess and the figures are inaccurate, the numbers used in your budget will be useless.

If you can review your prior year's figures with confidence, try to cultivate your strong areas and look for ways to increase performance or volume. You also need to analyze your weak spots. If possible, set up some type of internal control over the weak areas. A cost analysis will help you determine if you are actually making money on the sale of a certain product.

If your business is in its first year, your budget will involve a little more homework. Keep in mind that a budget is an expression of your goals. Try to determine the number of billable hours you might reasonably expect to charge for within a year's time. If you are in sales, try to establish the number of items you will be able to sell. After determining the revenue portion, you should look to your expenses.

Some expenses, like rent, will be fixed because they do not change from month to month. For example, if your office space rent is $3,000 per month, you must still pay $3,000 per month, regardless of whether or not you have made any sales or earned any income.

Another type of expense is a variable one. In budgeting, this is known as a variable "cost," which is a cost that increases with the level of sales or income. They are variable because the more income you generate, the greater the costs you will incur. Sales commissions are an example of a variable expense--the greater the sales revenue, the greater the sales commissions. Do research before starting your business to determine what comprises your fixed and variable costs.

Certain types of businesses have an established profit margin. This information may be available by simply asking other professionals in your field. Your accountant sees thousands of tax returns and may be able to give you an idea of the average "cost of sales" or "profit margins" for your type of business. The averages for certain industries are also compiled by financial ratings organizations such as Dun & Bradstreet, Moody's and Standard & Poor's. For example, if you are starting a coffeehouse, you could compare your sales, gross profit ratio, and net income to the averages for the retail sales/coffee industry compiled by Dun & Bradstreet.

It's amazine how many small-business owners don't know if they're making a profit on service, parts or sales. Others don't know whether they're making or losing money on a particular job. The purpose of the accounting and budgetary process is to help you answer these questions and make the right management decisions. You can't plug the leaks in your revenue ship if you don't know where the holes are.

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This article was originally published in the September 1997 print edition of Entrepreneur with the headline: Budget Basics.

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