The Essential Working Budget
If you are like most small business owners, you collect your financial information and give it to you accountant in January. About April 14th he will ask you to sign your tax return and then disappear. This kind of feedback on the performance of your business isn’t very good. Why? Because working this way always places you in a reactionary position instead of a proactive one. The year is over and you are finding out how well you did four months into the next year. In the old days that’s how business was done- you had to have an accountant prepare statements for you to see how you were doing. Those days are long over. Today, its way too easy to keep informed of your performance and way too important. Reviewing expenses and income each month allows you react to slumping sales and rising expenses.
Working budgets are a critical tool in managing your business today. Here’s how to setup and maintain yours.
When I say it’s easy to stay in control of this information, I am referring to the incredible progress made by accounting programs like QuickBooks. These programs are now so easy to use that NO ONE should be hand writing checks into a ledger anymore. I use QuickBooks Pro and it makes bill paying and payroll a snap. Today’s programs are connected to the internet so that tax tables and filing forms are updated directly into your system ensuring that you are always compliant. In addition, you can create complete backup versions that can allow you to email your large files to your accountant for review at any time- no more toting around a bunch of files with papers sticking out everywhere.
But back to the budgeting. Let’s talk about how to do it. The new systems allow you to set up budgets for every operating expense you have simply by using last year’s data. This means you can create company budgets in QuickBooks instantly, but don’t be tempted to stop with this simple set up. There are two basic types of expenses for businesses- variable and fixed. Fixed expenses are those that do not change- they are the same every month or vary only as a percent of something else. In other words, fixed expenses don’t need too much monitoring once they are established for the year. For example, your waste removal costs $40 per month last year. This year it goes up to $47, but it will stay fixed until your contact expires. Variable expenses however rise at any time. These are costs like payroll, advertising or supplies. Keeping track of variable costs each and every month is extremely important. Doing so gives you the chance to correct things that are hurting your business. It can also point you toward things that are helping and should be increased. The great thing about budgeting variable expenses is that you have a reference point for making decisions. For example, once you have determined how much you can spend on advertising this year and placed it into the budget, it is much easier to say no to unbudgeted requests that will inevitably come your way several times in the coming year.
Setting up your budgeted expenses:
- Use last year’s results together with any knowledge you have about price increases or decreases to compile an annual expense for every line of your operating statement.
- Breakdown each expense by month. Don’t be tempted to average the total out and enter the same amount each month, instead use last year’s actuals and your knowledge of upcoming changes to enter the expenses by the amount you will pay each month. For example, if you process your payroll every other week, there will be two months every year where you have 3 payrolls instead of two. Use a calendar to figure out when that will happen and enter larger expenses for those two months. Doing so will help you understand what to expect in the coming year.
- If you don’t have a system like QuickBooks which will automatically record your budget by month, you can create something very similar with an excel spreadsheet. Just leave an open column for each month next the one you’re placed your budget in for the actual figures to be posted.
Setting up your budgeted income:
Next it is time to create the income part of your budget. These are the sales you expect to get. You should breakdown sales by category. Separate gallery merchandise sales from custom framing sales.
- Use last year’s information first. Look at each month and adjust for huge sales that cannot be counted on this year.
- Instead of assuming sales will occur at the same rate as last year, use the last 90 days of sales to create a “trend”. If sales are trending up or down, reflect that in your projections for next year. In this economy, we are seeing very strange swings in sales- they go up dramatically and then die. This is why you must look at your sales trends throughout the year and keep adjusting your predictions based on the latest results.
- Sales must now be reduced by your Cost of Goods Sold- the amount you pay to buy the product you sell. Each category of sales has a different COGS and this can be quite confusing to calculate. If you have no experience here, ask your accountant to provide you with it. Knowing your COGS will also tell you what your gross margin is- the amount left over to pay your expenses. This is the number you need to balance your budget. Once your accountant has helped you do this, you can learn to do it yourself in future years.
Manage your results:
The next step is to be sure the budget is balanced. If your expenses are greater than your income, you must cut expenses. This takes experience to understand what to cut. You will get better and better over time, but the key is that you know going into the year that you have adjusted expenses and projected sales that show a profit. Remember you don’t have the same luxury as the government- you MUST balance. Now that you have a balanced budget, you are ready to start the year! You now have the ability to compare your budgeted expectations to what actually happens. Doing this each and every month allows you to react in real time to unexpected results. It allows you to truly manage your business.
- Post the actual income and expenses next to your budget each month. This is something you can do on your excel spreadsheet if you do not have an accounting program. If you do have a program, it will compare the budget to the actual automatically and produce a report that shows you where the budget differed from the actual.
- As you post the actual figures each month, note any that are vastly different than your budgeted figures. If there is a big problem, try and determine why and start taking steps to fix things.
- At the end of every three months (quarter). Add up the results for that period and compare the three month total to the actual. At this point, you should change your budget for the upcoming months based on the results you have seen in the previous quarter. Revise your sales based on the current trend, correct expenses that are wrong and then REBALANCE your budget. This is the key- you need to rebalance each quarter in order to avoid cash problems or take advantage of sales increases.
Managing your business based on comparing anticipated results to the actual results and then correcting your anticipated results is how businesses stay healthy and make the most out of upswings. Doing this today is absolutely essential to running a profitable business. Don’t wait for your accountant to tell you how you are doing. Go out and buy an accounting system that gives you the information you need to get your own answers. You’ll love the feeling of being in control of something so important to your future!