Creating a realistic budget is an efficient way to keep your business profitable. To do this, you need to estimate revenue, predict costs, and leave room for a reasonable profit margin. It won't be easy at first, but creating an effective budget will help your business stay afloat and be successful in the long run.
Steps
Part 1 of 3: Understanding the Basics of Budgeting
Step 1. Familiarize yourself with the concept of budget
Budgeting is like a roadmap for your business; provides an overview of future expenses and revenues. A properly drafted budget includes realistic revenue estimates and precise spending plans. Following it in compliance with the established parameters ensures that the company makes a profit and achieves its objectives.
- For example, imagine that your company needs to plan the business for the following year. The budget summarizes the estimated revenues, then includes a plan for expenses that should not exceed the revenues, in order to guarantee a profit.
- In a balanced budget, revenues are equal to expenses. A surplus indicates that revenues exceed expenses and a deficit the opposite. Your company's budget should always include a surplus.
Step 2. You need to understand why it is essential to have a budget
A well-thought-out budget is very important to the success of your business, as it allows you to compare what you earn against what you spend. Without a clear budget plan, it's really easy to squander all revenue over time, leading to losses, debt increases, and even business closure.
- A budget should address all of the company's expenses. For example, if you notice in the middle of the year that your business desperately needs new computers, you can consult your budget and find out how much surplus you have for the rest of the year. At that point, you will be able to find out about the costs of a computer upgrade and understand if you can support them while still making a profit or, alternatively, if future revenues allow you to take out a loan to purchase the computers.
- The budget also helps you to understand if you are spending too much and if you need to make cuts over the course of the year.
Step 3. Know all parts of the budget
A business budget has three basic sections: sales (also known as revenue), total costs / expenses, and profits.
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Sales:
this term refers to the total money your business makes, from all sources. The budget includes an estimate or forecast of future sales.
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Total costs:
the expenses incurred by the company to generate sales. These include fixed costs (such as rent), variable costs (such as the materials used to create the products) and semi-variable costs (such as salaries).
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Profits:
the difference between revenues and costs. Since profits are the goal of a company, your budget should include expenses that are lower than expected revenues to ensure you get a good return on your investment.
Part 2 of 3: Predict Revenues
Step 1. Consider the current situation
If you have a business that has been in business for a few years, you need to look at previous years' earnings and make changes for the next 12 months to forecast revenue. If you've just started a startup and have no previous experience, you need to estimate total sales, unit price of products, and do market research to figure out what amount they can expect to earn a business of similar size to yours.
- Remember that revenue forecasts are almost never accurate. Try to provide the best possible estimate based on your knowledge.
- Always make conservative estimates. This means that you need to consider the lower bounds of the possible range between the sales volume and unit price values.
Step 2. Do some market research to establish a price
It is especially important for new businesses. Study local businesses that offer similar goods and services to yours. Take note of the prices of those products.
- For example, imagine you are a psychologist and open a practice. Therapists in your area have rates from € 100 to € 200 per hour. Compare your qualifications, experience and services you offer to competitors and estimate your price. You may decide it's wise to start at $ 100.
- If you offer multiple products and services, research all of them.
Step 3. Estimate your sales volume
This value indicates how many units of product you will sell. Revenues are equal to the unit price multiplied by the number of goods or services offered. Consequently, you need to estimate how many products you will sell in a year.
- Do you already have clients or contracts? If so, include them in your estimate. You can assume that customer word of mouth and marketing will allow you to increase your sales volume over the course of the year.
- Compare your business with others that already exist. If you have colleagues with well-established businesses, ask them how much they sold in the beginning. For a therapy study, your colleagues might tell you that in the first year they had an average of 10 hours of sessions per week.
- Consider the factors that determine the volume of sales. For example, if you are a psychologist and want to open a private practice, your reputation, recommendations and advertising will bring you clients. You can decide that based on your resources, a new customer every two weeks is a reasonable estimate. You can go ahead by predicting that each client will pay for one hour a week and continue to sit for an average of six months.
- Again, remember that revenue forecasts are purely estimates.
Step 4. Use historical data
This is very important if you have a well established business. An effective forecasting strategy is to look at the previous year's revenues, then look at the changes that will take place over the next twelve months.
- Consider the prices. Do you have reason to think they will increase or decrease?
- Consider the volume. Will more people buy your products or services? If your business has grown 2% each year, you can assume that the trend will continue over the next 12 months as well, unless there are major changes. If you plan to advertise your services a lot, you can expect higher growth, for example 3%.
- Consider the market in your industry. Is it expanding? For example, imagine you have a bar in a downtown neighborhood. You may know that the neighborhood is growing rapidly as more and more people move there. This is a good reason to expect your business to grow.
Part 3 of 3: Create the Budget
Step 1. Download a template from the internet
This is the best way to start creating a budget. A model contains all the information available and your task will simply be to fill in the blanks with estimates. This way, you won't have to waste time creating complicated tables.
- If you are having difficulty, consult an accountant. Accountants and bookkeepers are able to help businesses create a budget and, for a fee, can assist you in all aspects of the matter.
- A simple "business budget model" search is all it takes to find thousands of results. You can even find custom templates for the specific type of business you have.
Step 2. Decide on the profit margin you want to achieve
Margin equals revenue minus total expenses. For example, if you have estimated that your business will get $ 100,000 from sales and incur costs of $ 90,000, the profit will be $ 10,000. In this case, the margin is 10%.
- Do some research on the internet or ask a financial advisor what the typical margin should be for a business like yours.
- If 10% is the typical value for your industry, consider that if you have estimated € 100,000 for revenues, your expenses should not exceed € 90,000.
Step 3. Determine fixed costs
These are the expenses that generally remain unchanged throughout the year and include items such as rent, insurance and property taxes.
- Add up all these expenses to find out the fixed costs for the following year.
- If you have past financial data available, use fixed costs and adjust them based on rent increases, utility bills, or the introduction of new expenses.
Step 4. Estimate the variable costs
The cost of raw materials and inventory to make sales is the main variable cost. For example, if you have a car dealership, you will include the inventory you buy and sell every year.
This value varies according to the volume of sales and is therefore called variable cost. You can use the revenue forecast to determine this. For example, if you plan to sell 12 cars in the first year, your inventory costs will be buying those 12 cars
Step 5. Estimate the semi-variable costs
These are the expenses that usually have a fixed component, but also vary according to the sales volume. For example, telephone or internet rate plans have fixed costs, plus surcharges for use beyond a certain deductible. Salaries are also an example. You might expect a salary for an employee, but overtime and extra hours due to a higher volume of work can drive that cost up.
Add up all the estimated semi-variable costs
Step 6. Add the three types of costs and make changes
Once you have the totals for each type of cost, add them together. This will give you the total annual expenses. At this point, you can ask yourself some important questions.
- Are the total costs less than the revenues?
- Do the total costs guarantee margin profit equal to or greater than the target?
- If the answer to any of these questions is no, you need to make some cuts. To do this, analyze all the costs and find items you can do without. Labor cost is one of the most flexible areas in which to make savings (although you risk pissing your employees off by paying them less). You can also find buildings with lower rents or reduce the cost of bills.
