How to budget as a small to medium business
Posted on 5th November 2022
As we enter economic turmoil and the possibility of another recession looms on the horizon, many small to medium business owners are rightfully wondering how to ensure their business remains profitable and continues to grow.
Rising costs for goods, utilities, and fuel have forced many businesses to either raise their prices in line with the rising costs or swallow them in their profits out of fear that if they raised their prices too much it would put customers off. Some have adopted a combined approach, increasing their prices slightly but not enough to cover the full rise in costs and reducing their profitability slightly to cover the remainder.
But how do you know which approach is best for you and your business and how do you work out how much to increase prices by to meet rising costs?
The simple answer is budgeting. Now, this may well seem obvious, and there’s a risk this may be teaching you to suck eggs, but you would be surprised by how many businesses do not have an adequate budget in place.
Some of the main reasons why many small businesses fail, usually within the first few years, is because the owners lose focus on what they are trying to achieve, the business runs out of cash, or pricing and cost issues. The latter two reasons sound very similar, and are often linked, but we’ve included them separately because a business doesn’t always run out of cash just because they’re costs vs pricing doesn’t add up. Business owners, especially new and inexperienced ones, can often get carried away spending money they think is available when in fact it’s required to meet certain future costs. That doesn’t necessarily mean their pricing is wrong, just that they hadn’t planned properly for the future and have spent cash that should have been put aside.
All three of these problems that small to medium business owners often face can be positively affected, prevented, or sometimes completely resolved using appropriate budgeting.
Budgeting isn’t just a series of calculations to know what’s coming in and what’s going out. A good budget allows you to plan effectively, set both short- and long-term business objectives, and helps build a road map for your business to drive growth and reach your goals. Deciding what your goals will be before you set out your budget will allow you to manage your funds accordingly and plan ahead.
If, for example, you have a short-term goal of paying off a business loan and a long-term goal of increasing marketing expenses crucial to driving growth, you can include these within your budget and plan your outgoings accordingly.
If you want to pay off a business loan in a shorter timeframe than originally set out to reduce the overall interest paid, you can plan for surplus funds to be put aside for this purpose. A well-executed budget will allow you to see how much your business can afford each month to put towards the loan.
Similarly, you may want to increase your marketing budget to reach more people, increase traffic to your website or physical store, and drive overall growth. Including this goal in your budget will allow you to plan how much your business can afford to increase its marketing spend by. It even allows you to set future benchmarks to help reach the long-term goal too: if we pay off this business loan by X date, we can put the freed-up cash towards our marketing budget to increase sales.
How do I create an effective business budget?
Of course, every budget will be unique to each business due to the differing goals and circumstances that every business has but there are a few things every budget should have in common to be considered effective and adequate.
You need to know the total ongoing monthly expenditure of your business, what it costs to run, so that you have a baseline figure that your business must make each month to remain operational. There are a number of different types of costs that your business will have. Some will fluctuate on a monthly basis, some will remain fixed, and others may be a one-time cost.
These are costs that remain the same each month. You know how much is going to be needed to pay them and are usually very easy to work out. Fixed costs will be expenses such as rent, salaries (excluding commissions or bonuses), internet and phone contracts, web hosting, marketing agency fees, payroll and accounting services, and insurance contracts. These only usually change due to a price increase or a variation of service, such as increasing your broadband speed contract or choosing to add an extra service that your marketing agency provides. Fixed costs can be included in your budget and forecasts for the foreseeable future and adjusted according for increases as there is usually ample notice given for any changes.
You can add these fixed costs up and this will give you your total fixed costs per month.
Variable costs can fluctuate each month, usually within certain parameters. Some variable costs you will have control over and others, not so much. Examples of variable costs include utility bills based on usage (electricity and gas), travel expenses, cost of goods purchased, shipping fees, and monthly bonuses and commissions. Some variable costs are directly linked to other areas of your business, like sales and profits. For example, if your sales team achieve their performance targets, they may be rewarded with a performance-based bonus or commission. These costs would only be paid out if sales targets were hit, which would mean your sales would be high enough to cover the payments and consequently, your profits should be higher too. Some months where your profits are higher, you could spend more on these variables – such as purchasing more of a certain product that sells well during the current or upcoming quarter. Other months, when profits are lower, you can cut back on some variable costs, or they may be reduced themselves – if profits are lower, sales could be lower, which would mean less commission or bonus costs are to be paid.
Over the course of several months or a year, you’ll have a good indication of how your variable costs fluctuate and their relation to your business’ performance or the time of year. This will allow you to make reliable financial projections to use within your budget.
It’s virtually impossible to predict every infrequent cost that will occur, but you should have an idea of any impending costs that will need to be factored into your budget. One-time costs can be anything from new IT equipment purchases, security system installation or upgrade, or new company vehicle purchase. These are irregular but planned costs and will need including in your budget to ensure you have the funds to cover them when payment is required.
Other one-time spending can be completely unexpected, such as mechanical failure and replacement of machinery or the cost of insurance excess after an accident involving a company vehicle. It is a good idea to factor in such possibilities and include an extra buffer within your budget in case of emergency or unexpected costs cropping up. This will ensure that should any costs occur that you hadn’t planned for, it won’t catch you unawares or cause too much of a financial strain to your business.
Once you have worked out all of your outgoings, your fixed costs, variable costs, and one-time spending (including a buffer for potential unexpected expenses), you can add these together to form your total expenses, or total costs.
Revenue from all sources
After working out all your outgoings and forming your total costs figure, you’ll have the baseline figure needed to remain operational – the absolute minimum your business needs to make to survive.
Next, you’ll want to work out your income from all sources to ensure that your total costs are covered and you’re making a profit. Depending on the type of business you have or your business model, you may have multiple streams of revenue. If you’re a freelancer, for example, you may earn an income from the clients you work with, the tutorials you run, and perhaps you’ve written a book on your specialism and sell that online too. Maybe you run an independent store, which would likely mean you have a single revenue source to manage.
Whether you have one revenue source or several, you’ll need to pull them together to give your total monthly revenue for your business.
Total Revenue – Total Expenditure = Total Net Income
Once you have worked out your total revenue from all sources and your total expenditure or costs for your business, you can work out your business’ total net income, which is simply your total revenue minus your total expenditure/costs.
This figure will tell you how much money your business is making and is a great way to know whether you can afford to invest back into the company to help boost growth or whether you need to cut costs to meet future obligations.
Informed Financial Planning
Once you have worked out your business’ total net income and have a figure for this for each month of the year, each quarter, and an annual figure, you can begin to project cash flow, which is useful if you want to borrow against the business for any reason.
When projecting cash flow (depending on your industry and type of business) you’ll need to factor in a few things. If you invoice for work done or services rendered, you’ll likely have a grace period to give clients and customers time to make payment. This could be 14 days, 30 days, or even 60 days. Whatever grace period you give, you’ll need to allocate some funds in your budget to cover late payers or non-payment.
You’ll also want to take industry or seasonal trends into consideration too. For example, if you run a retail store, you may see a higher revenue in the lead up to Christmas and during January sales with a dip in revenue in February and March. If this is the case, it would be unrealistic to keep business goals or spending budgets the same for every month of the year. If you do experience seasonal fluctuations, factor this into your budget and your sales and marketing plan so that you make the most of the higher earning months to sustain your business during the off season.
A business budget is more than just working out your income after costs. A good, robust business budget helps you set and manage your spending goals. Working out your costs and your revenue, allows you to get a picture of how much money you have available in your business. Consequently, this gives you a base figure to work from with regards to investment and spend. Wise spending can help your business grow quicker and more manageably. Reckless spending, or ill-informed spending, can hinder growth and even put your business at risk. This is why setting spending goals based on your revenue and income as well as cashflow projections is important; it helps ensure you are spending money in the right areas and not wasting it on pointless endeavours. For example, you could be spending money each month buying equipment and materials that end up never being used or you don’t use anywhere near the amount you’re purchasing. This is a waste of spend. You could reduce the amount you purchase and reinvest the extra money into your marketing budget to help increase leads, sales, and revenue, which would benefit your business far more.
Working out your earnings vs your outgoings and using these to make informed business goals is what makes budgeting so important for business growth. Without a detailed and robust budget, it is very hard to properly predict, manage, or sustain business growth.
If you’d like to discuss your business budget or would like any assistance with your business accounting in any way, contact Abaqus and we’ll be more than happy to discuss how we can help.
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