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Budget Basics

Why your new business needs a formal budget from day one.
September 1, 1997
URL: http://www.entrepreneur.com/article/14532

Budgeting is an integral part of society. Each day we try to budget our time, our meals, our kids' time and our money. Most of this process is done mentally and never put on paper. Just as families budget time and money, your business must also develop a financial plan. This type of budget is simply a formal written summary of your goals and intentions in terms of dollars.

There are several types of budgets with which you may be familiar, such as: the negative Federal Budget, the "try to break even" budget and the "I'm going to make a profit" budget. Since you are starting your business for the purpose of generating a profit, we will concentrate on this profit motive. A good accounting system makes a significant contribution to your management process. Keeping track of the historical data, cost relationships and various overhead items will help you make the proper management decisions. Accounting will translate your business plans into measurable financial goals.

Why Budget?

Budgeting offers many advantages to your business. It requires that you look at past historical performances by comparing your "actual" revenue and expenses to your "targeted" revenue and expenses. (If you're just starting your business, you can use industry association standards for these figures. More on this later.) You can then evaluate your accomplishments. By reviewing these figures you create an early warning system for potential problems.

Budgeting also requires you to look ahead and formalize future goals. By establishing a budget, you can set goals for achieving a certain level of income and monitor your expenses. Many small-business owners have remarked that their increase in profit margins did not occur until they had a written revenue goal and a method with which to monitor expenses. Other business owners need to know their sales levels in terms of dollars and how hard they need to work to make the budget work. You'll know you are on top of your business when you can tell your accountant that you need to sell 3.25 items per day in order to make your budget work and meet your financial goals.

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.

Business Basics

By Christina Grace Peterson

Running your own business creates a demanding lifestyle. Everything rides on your decisions, and making those decisions requires knowledge. The six-volume book series, Run Your Own Business (Prentice Hall, $13.95, 800-922-0579), gives a practical overview of the core elements of any business, from personnel, legal, finance and accounting issues to the uses of publicity and computers. Eight experts in their fields give start-up entrepreneurs a working knowledge of the key areas and tools of running a business.

In Choosing a Legal Structure for Your Business, Stuart A. Handmaker humorously gives nuts-and-bolts advice to guide new entrepreneurs through the legal minefield of small-business operations. Included are examples of articles of incorporation, sample forms for a partnership agreement and tips on choosing the best legal structure to protect yourself and your new business.

Or maybe you're wondering how to plan and execute your own advertising campaign. Donna G. Albrecht describes dozens of free and low-cost ways to market your business in Promoting Your Business With Free or Almost Free Publicity. She also provides a helpful resource directory and ready-to-use worksheets to help you implement your promotional program.

Also in this series are: Financing Your Business, by Iris Lorenz Fife; Day-To-Day Business Accounting, by Arelene K. Mose, John Jackson and Gary Downs; Managing Your Employees, by George Devive; and Computerizing Your Business, by Michael C. Albrecht.

Reprinted from Day To Day Business Accounting (c)1997 by Arlene K. Mose, John Jackson and Gary Downs. Used by permission of Prentice Hall Career and Personal Development. All rights reserved. To order, call (800) 922-0579.