Editor's Note: Learn from a panel of experts and entrepreneurs who have successfully financed their own ventures and are helping others do it at the Thought Leaders Live 2013 event May 29, in Long Beach, Calif. Event and ticket information can be found here.
Many entrepreneurs launch a new business without carefully analyzing the financial prospects in advance. They think all they need to do is sell enough of the product to create a profitable business, but this is seldom the case.
The act of budgeting for your business forces you to think through all the important numbers and to develop a picture of what your business is going to look like in three, six, nine and 12 months. A budget is a powerful business tool that will help you make better decisions. It enables you to develop and maintain a thorough understanding of the internal financial workings of your business.
One of the most important skills of any entrepreneur is the ability to prepare budgets and accurate financial forecasts for the business. Your ability to set financial goals for sales, expenses and profits is a true measure of your ability to succeed in business.
The purpose of a budget is to give you a visual description of the expected financial results of your business activities. When preparing your budget, remember that:
- It should cover 12 to 24 months of business operation.
- You can use paper spreadsheets that you fill out in pencil.
- Computer programs like Excel will enable you to change numbers quickly.
- You should work out a complete budget before beginning business operations.
- Each month, you should review, revise and update your budgets for the next 12 months.
A basic business budget contains four major numbers: projected sales and revenue; projected total costs of achieving that level of sales and revenue; the profit or loss from operations based on the two numbers above; and the cumulative total of profits and losses over time.
The first and most important number is the top line-the estimated sales for the month. This number should be the result of a complete analysis of your marketing and sales activities, so your ability to project this number with accuracy is a key measure of your talent as a businessperson. Make sure this figure contains high, medium and low sales estimates.
Your sales and revenue projections should be based on experience, market analysis and research. However, it's worth nothing that your business should still be profitable even if your low sales estimate turns out to be correct.
The next part of your budget should include all the costs of operation involved in producing and delivering the product or service to customers. These include:
- The costs of purchasing or producing the product or service.
- Sales and marketing costs.
- Your business's administration and operation costs.
- All fixed, variable and semi-variable costs of business operation.
Your final number should include 100 percent of all out-of-pocket expenses necessary to achieve your estimated sales revenues.
The next part of your budget is the total profit or loss from operations for that month. There will sometimes be months of the year where your business loses money. In a new business startup, the first few months will usually show losses. The general sales and profit trends are most important.
Lastly, your budget should reflect the cumulative profits or losses of the company over a period of months. Profits and losses are added together each month to get a total; these totals tell you when your business will break even and begin earning a profit. The total of losses will tell you how much money you will have to borrow or provide to the business before it is profitable. An accurate budget should reveal the truth about your business's potential.
Each major number in your budget should be reviewed each month. You should compare the actual results in each category against the projected results. The act of studying each number each month will improve performance in that area.
When entrepreneurs invest in the preparation of accurate business budgets, they save enormous amounts of time and money-and often many months and years of wasted effort.