Basic Budgeting for Your Small Business
Cashflow forecasts and balance sheets give you a headache? We go through the basics of business budgeting to make it much easier
When starting a business your head is often filled with grandiose dreams of becoming the new leader in your sector or changing the way the market works with your offering – it is unlikely that the prospect of drawing up a budget was what excited you about becoming an entrepreneur. But budgets are absolutely crucial in keeping control of your business and ensuring you have a realistic roadmap for success.
This article will provide you with an introduction to creating a budget – we cover sales, costs and cash budgets, and how to convert these into a projected balance sheet. Finally, we examine what to do when your actual figures differ from predictions, and the steps you can take to address this.
How do I draw up a sales budget?
A sales budget essentially predicts how much you expect to sell month-on-month over the next year. It should predict how much you expect to sell of each product or service and how many turnovers this will generate (remember to exclude VAT if you have registered for it).
When drawing up your predictions, you should start by taking into account what sales you expect you will make. Start from the confirmed orders you have and look at regular customers who order your products in a predictable fashion but try not to assume too much. Looking at previous sales figures will also help – use your own and sales achieved by comparable businesses in your sector.
Your ability to meet demand, the state of the market and the anticipated impact of sales, price changes and marketing activity should also be factored. For instance, do you plan to change the price of a particular product at a certain time? What is the current economic climate?
Finally, you should consider what the competition is doing. Are they getting stronger? Do you expect them to take business away from you, or vice versa?
After you have drawn up predictions, taking into account the above factors, take a sober look at the figures. Ask yourself whether they look realistic – if not, go back to the drawing board and figure out where your calculations went wrong.
How do I draw up an expenditure budget?
After a sales budget, which essentially predicts turnover, you should draw up an estimate of your costs month-on-month over the next year. Costs can be divided into two distinct categories: fixed costs or overheads and variable costs
Fixed costs or overheads are costs your business will incur that are not dependent on the volume of goods or services you produce. Fixed costs might include rent, business rates, interest on loans, employee wages, utility costs (including telecoms) and insurance.
Variable costs, on the other hand, are the costs that will change according to how many goods or services you sell, and hence will be tied in with the figures in your sales budget. Variable costs might include raw materials, delivery and distribution, and overtime or temporary staff.
How do I draw up a cash budget?
When you have created your sales and expenditure budgets, you can use them to create a cash budget – this is a consolidated budget that will predict your actual cashflow month-on-month.
When creating a cash budget, you should take into account timing. Look at when you actually expect to be paid for sales, and the dates you will have to pay out costs such as staff salaries and office rent. Also, look at any bad debts as you should try and account for a certain amount of sales that will never be paid for.
Finally, factor in additional incomings and outgoings; take into account other money your business will be receiving and paying. This might include tax payments, finance (such as investments or grants), capital expenditure and VAT payments.
Using the information you have gathered, look at your current bank balance and work out how much cash you will have at the end of each month, working sequentially.
How do I use a projected balance sheet?
Your sales, expenditure and cash budgets can now be used to create a projected balance sheet – this is a month-on-month projection of how your performance will affect the total value of your start-up’s assets and liabilities. Assets will include cash in the bank, accounts receivable, buildings, equipment and stock; whereas liabilities will include, outstanding credits, loans and capital put into the business.
Creating a projected balance sheet has many uses, including checking whether your budgets work. Every time a transaction affects an asset, it must also affect a liability equally – your assets and liability figures should always be the same. Discrepancies can point to problems with one of your budgets.
Also creating a projected balance sheet will show the value of your business to prospective backers as banks will often insist on a balance sheet before they provide a loan, and it will help to provide you with information about the business. Balance sheets can provide a useful summary of how your business is doing generally.
How do I use my budgets to identify problems?
Budgets allow you to stay in control of your business – you can spot problems on the horizon and nip them in the bud before they become reality. Particular issues a budget might shed light on include underperformance, running out of cash and overtrading.
Whilst costs exceeding sales income is perfectly normal for a business, especially in the early stages, if the deficit is likely to be endemic then you need to look at how you can boost sales or cut back on costs.
Additionally, if your budget shows you will exceed your overdraft limit at any point, you need to take action. You might want to call in debts faster, arrange a deferral of payment to suppliers until the new cash comes in, or arrange new finance.
Finally do not ignore overtrading as a potential problem – it is all too easy to bite off more than you can chew and end up with not enough capacity to fulfil orders.
How do I use my budgets once I have started trading?
You should compare your budgets with your actual figures month-on-month to check performance against predictions and identify problems. In particular, compare actual sales figures with your sales budget and look at whether turnover was higher than expected – was this due to a one-off order, a surge in business or simple timing of payments? Also, check whether turnover was lower than expected or whether a particular product performed differently than expected.
Another key comparison to make is actual costs against your budget. In particular, look at the variation of fixed costs – is a rise in a particular cost permanent or a one-off, and variation of variable costs, investigate what was the cause of this. Did the cost of raw materials rise, or was the process more wasteful than you expected?
Finally, compare actual cashflow with your budget. In particular, look at the timing of payments – often cashflow will differ from your cash budget because customers take longer to pay. Change your upcoming cash budgets to reflect this.
Budgeting should be an ongoing process. If actual figures differ from what you expected, change your budgets to reflect this, so you always have an accurate picture of how your business is doing and a clear roadmap for the future.