How to Build and Maintain a Realistic Annual Budget for Your Small Business
According to a U.S. Bank study, 82 percent of small business failures happen because of poor cash flow management or due to a poor understanding of how cash flow contributes to a business. And many other small businesses fail because they don’t plan their annual budgets or account for their different expenses appropriately.
Whether you have a small business website that drives sales or a traditional brick and mortar store or both, here are some things you’ll want to do to ensure you’re able to build and maintain a realistic annual budget for your small business.
Understand Why Your Business Needs a Budget First
Budgets help you do much more than manage expenses and costs for your small business. They also help you determine how much money your small business will need to bring monthly and annually so you can maintain a healthy profit margin. You can use a budget to help you decipher what revenue streams to rely on or produce to generate healthy cash flows on a rolling basis. And they allow you to plan for sales cycles, peak periods of business, and when and how you need to stock your inventory, as well as help you plan marketing and promotional activities.
Planning for and following budgets has an added benefit of helping you to maintain documentation necessary for filing taxes and or applying for lines of credit with financial institutions. They also offer levels of transparency and trust when shared with your employees, contractors, partners, etc. Essentially, budgets should be thought of as crucial business planning tools.
Identify the Components of Your Budget
At the most basic level, your annual budget should always include your costs, expenses, total sales, and revenue. You’ll want to monitor it to ensure that your total sales and revenue are always projected to be greater than your costs and expenses. Follow one of the two basic equations to determine your profits and sales revenue:
“sales = total cost + profit” or
“sales – total cost = profit.”
First, separate your different revenue streams before you tally them together. This way, you’ll be able to differentiate which revenue streams are bringing in the most money and which ones aren’t. Different revenue streams can include products sold inside a store, on your e-commerce website, wholesale, etc. And be sure to include your projected revenue (the amount you think that your business will generate) as well as your actual revenue once it’s been officially earned.
You will want to divide your costs and expenses into 3 categories:
- Non-flexible expenses – those which your business must always pay to operate, such as rent for a building, electricity, monthly fees, etc.
- Semi-flexible expenses – include the costs that fluctuate based on sales volume and business need, such as fees for contractors, advertising costs, etc.
- Flexible expenses – those that should change based on sales volume, such as costs associated with materials needed to generate or ship products.
And don’t forget to include one-time expenses and costs that come only once a year or less on your annual budget, such as a computer, computer software, furniture, etc.
Always Do Your Research for Realistic Expenditures and Figures
When determining the projected expenses or revenue for your annual budget, be sure to do your research first so that you come up with realistic expenditures and figures. If you skip this step, your budget will never be accurate or very useful.
For example, let’s say you need a new computer for your business. Before you insert a figure on your budget spreadsheet for what the projected cost will be for your computer, do your research first. Determine what type of computer you’ll need and what its average cost is, then use that figure. While one type of computer may only cost $500, the one you really need for your business might end up costing double that amount. Or let’s say you’re projecting that your e-commerce business will bring in $25,000 monthly. Before you insert this number on your budget, complete some industry-related research to ensure this figure is realistic and tangible based on your specific sales model and the stage your business is in currently (i.e., newer businesses may not be mature enough yet or well-known enough yet to generate the same sales volumes that 10-year old businesses will).
Basically, never blindly insert numbers and figures into your budget. Always do your research to come up with your financial projections. And luckily, once your business has at least one year of financial history and data, you can use your very own figures to determine your anticipated expenses and revenue moving forward.
Understand Your Own Business’s Sales Cycles
When projecting your annual and monthly income and expenses for your budget, be sure to account for your specific business’s sales cycles. For example, if you operate an ice cream shop, you should account for sales being much higher during the summer months when it’s hot outside and children are out of school, as compared to winter months when it’s cooler and children don’t have very flexible schedules.
And you must account for the nature or your specific business and where it’s located, how it’s being promoted, and your business model too. For instance, if your ice cream shop is next door to a school, your sales might actually end up being much higher when school is in session and not during the summer months, especially if you advertise specials for your ice cream during the hours after school lets out.
Update Your Annual Budget Monthly
Each month, insert your actual expenditures and income next to the projections you made before the month began to see if you are following and maintaining your annual budget. Completing this step is the only way to ensure that your business won’t spend more money than it’s earning on a rolling basis throughout the year. It will also help you identify when a certain revenue stream is performing under par, where you might be able to cut back on expenses and tally your profits so that you aren’t operating at a significant loss for the year.
Don’t Be Afraid to Make Changes that Have a Positive Impact
While building an annual budget helps you plan for the financial health and stability of your business, it’s not entirely set in stone. You might want to make periodic changes that have a positive impact on your business and its bottom line. For example, let’s say you spend $200 per month for an invoicing platform, but halfway through the year, you discover a different invoicing platform that costs significantly less and won’t take much time or money to use. Or perhaps you discover a new revenue stream to tap into that won’t cost much to initiate and maintain halfway through the year. After doing your research and verifying how such changes will impact your business, don’t be afraid to make them before the year is over if their positive influence far outweighs their negative influence.
Plan for the Unexpected
It’s impossible to know when accidents will happen – when a computer system will crash, or when inventory might unintentionally get damaged. Be prepared for unexpected expenses to come up every now and then, and account for them. When building your annual budget, be sure to include an emergency fund or failsafe of some sort so that when unexpected expenses arise, you’ll be able to dip into those funds as needed. And if you don’t dip into this fund for the entire year, it can automatically roll over to the following year.
Hire Experts and Use the Right Software and Tools
You already wear enough hats for your company. Don’t be afraid to rely on financial experts you can trust when building your annual budget, especially if you’re business is new.
After you build your business website, make sure you have the right tools to monitor its revenue streams and expenses along with those for your brick and mortar stores. You’ll want to ensure you have the right software and tools that integrate or work well with your website for:
- Sending invoices and paying bills
- Accepting payments
- Tracking inventory and operational expenses
- Distributing payroll
- Handling customer support tickets
Building and maintaining a realistic annual budget for your small business is critical to its success, so keep the tips above nearby to ensure that yours remains useful and effective.