Breaking Down A Small Business Budget
By Gregory Perrine - eGuide Founder/CEO
Forecasts and Projections for Small Businesses
Operating a small business can feel like rowing a small boat with leaks everywhere. It takes agility, speed, and sometimes just pure will and resilience to keep the boat afloat as business leaders move from one crisis to the next, trying to patch things up as quickly as possible.
If you're a small business owner, I want to take a moment to say, "great job". It's not said often enough to the person managing the daily crises. Running any small business is not for the faint of heart. Running a small business that is trying to grow while maintaining profitability is even harder.
One important thing to remember is that budgeting for a small business is often more of an art than a science. That's not to say there's no point in budgeting because it will all change anyway, but there is an approach that can allow your budget to be a living and breathing document.
Knowing where to draw parameters around each month, having the tools to confidently identify your break-even point, and leveraging past data to predict the future can greatly impact how you manage those little leaks and, honestly, can lead to a more restful night of sleep.
Key Terminology
Before we dive into some strategies, let's take a quick moment to define some key terms you'll encounter when working with your budget. Understanding and incorporating these terms into conversations with your accountant can ensure that you're referencing the same thing and make communication easier.
Profit and Loss Statement - Also known as a P&L, this is a summary of the earnings (profit) and expenses (loss) of your business. It can be an effective tool to take a snapshot of your business on a monthly, quarterly, or annual basis. This report can also help you compare two moments of time against each other.
Equity - Refers to the value of the assets minus the liabilities of a business. It represents the net worth of the business.
Balance Sheet - Similar to the Profit and Loss statement, a balance sheet includes the profit and loss, as well as the assets (inventory), liabilities (loans and debt), and equity (retained earnings or cash on hand) of the business.
Cost of Goods Sold - (COGs) refers to the amount of money it costs a business when an item is sold. For example, if the raw materials for a dress cost $85 and you sell the dress for $300, the cost of goods sold is $85.
Chart of Accounts - A business's chart of accounts is how all profits, cost of goods sold, expenses, assets, liabilities, and equity are recorded and tracked. A numerical system is often used to summarize account centers to make tax filing easier when working with accounting.
Gross Profit Percentage - This is a calculation that takes the gross profit (the amount of profit left after subtracting COGs and labor), divides it by the total revenue, and multiplies by 100.
Gross Profit Percentage = (Sale - (COGs+Labor))/Total Revenue) * 100
Tracking these percentages can help inform business owners of key decisions like increasing prices, finding cheaper goods, or reducing labor costs.
How To Use Last Month To Help This Month
Now that we are more familiar with some of the terminology of budgeting, we can start putting the puzzle together. Before you get started, ask yourself a few questions:
What is the average monthly sales?
If you have COGs, what is the monthly average cost?
What is your total full-time labor cost?
What is your total part-time/contractor labor cost?
What are your total average expenses (excluding COGs and labor)?
If you cannot answer these questions, it's time to get to work! Depending on where you are in your business journey, you may be using an accounting tool that has varying degrees of functionality, such as Quickbooks, Freshbooks, all-in-one solutions like Zoho One, or even a Point of Sale (POS) platform like Square. You should be able to run a report using these tools to begin answering the questions above.
We recommend putting together a workbook that allows you to easily copy and paste report values into a spreadsheet. With a few simple but effective formulas, you can begin allowing your month-over-month performance to paint a picture of averages.
The end goal of tracking this information should be to ensure that you can distinguish between a good month, an average month, and a bad month. Drilling this information into your head allows you to operate with more confidence and clearer direction when addressing things with your team.
Are you interested in a template? We'd be happy to chat.
When To Spend & When To Save
Forecasting can sometimes be compared to gambling. No one can predict the future, as illustrated by the daily news, where there is always something that can completely upend your business. However, there is a big difference between betting the house and taking calculated risks based on factual trends.
Once you have your monthly averages and are consistently tracking your month-over-month (MoM) profit and loss, you will start to see some trends.
Do you have an expected “busy” month that will be engineered out of an event or trend in your industry?
Did you hire a salesperson that has been showing consistent growth MoM?
Are you able to control variable labor spending in any month to help with your overall cashflow?
These questions can help you engineer some space for purchases and conversely tell you when it's time to save.
As your business grows year over year (YoY), you will inevitably introduce new variables into the yearly equation, which can make forecasting and identifying those trends more challenging. Tracking where your business is coming from and what strategies are impacting your topline will help guide you in the right direction.
When in doubt, err on the side of caution. It's much easier to figure out a plan for an overage than to be working to make breakeven.
Operationalize Your Budget
Ideas are always improved through collaboration, and if you can create a living budget, then the continuous improvement of the document will come naturally.
Consider who on your team should be more knowledgeable about the financial aspects of your business. For many early managers, accounting terminology can be unfamiliar, and by allowing them to see the inner workings of the budget, they may better understand the "why" behind business decisions and communicate them to their direct reports.
After each month is reconciled, take an hour to meet with your team to review the questions outlined in this blog. Aligning everyone's vision so that they see the budget consistently can mean the difference between smart purchasing and foolish spending, informed decisions and guesswork, and focused growth versus relying solely on luck.
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