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How to Create a Small Business Budget

In our last post – Creating a Budget for a Small Business — we covered the why of this subject. In this post, we’ll cover how to create a small business budget — four simple steps that can bring about tremendous results in your business.

Budgeting is just about looking at the present situation and doing some simple algebra (don’t be afraid, it is VERY simple algebra), and if you give us a call, we are glad to help you check your work.  Below is how to create a small business budget in its basic form.

 

How to Create a Small Business Budget

 

Step 1 – Look at the big expenses

Look at top expense items (any expense that represents more than 10% of your revenue or 25% of your expenses). These are usually payroll, the cost of goods or services, rent, and marketing. Make sure you aren’t paying too much for any of those items, and that you are using them as efficiently as possible. It’s important to have a plan in place to review these regularly (quarterly or annually, depending on your business, is usually fine).

 

Step 2 – Separate fixed costs from the variable. Don’t be intimidated by the jargon

Fixed Costs – A simple definition of fixed costs is the expenses in a small business that will stay the same even if revenue goes up and down (or up and up). Usually rent, office supplies, the phone system, the office computer expense, et cetera are all fixed costs. If you own a restaurant, there are obviously only so many customers you can have in one restaurant, so at a certain point you would need to open up a new location. Then you would have a new set of fixed costs, but for most businesses, we have a set amount of costs that will remain the same up to a certain level of revenue.

Variable Costs – these are the costs that go up and down with revenue. If you sell shoes, this would include the cost you pay for the shoes you sell. If you run an electrical company, this would include the labor cost of the electricians you pay to do the work. The variable costs might also include the merchant credit card fees you pay if you accept credit cards (these obviously go up as sales increase). Look for any costs that increase or decrease as revenue increases or decreases.

 

Step 3 – Figure out your gross profit margin

This is the percentage of each dollar of revenue you will have after you cover your variable costs. If you run a shoe store, and you charge your customer $100 for a pair of shoes, but you only pay $30 for those shoes, then you make $70 ($100-30=$70) for every pair of shoes you sell – this is the gross profit.

A little simple division will give you your gross profit margin:

Gross Profit Margin = Gross Profit/Revenue

In this case your revenue is $100, and your gross profit is the $70, so your gross profit margin can be found with the following equation: $70/$100=70%. Your gross profit margin is 70%. This means that for every $1 of revenue that you make, you get $0.70 to apply to overhead fixed costs and net profit.

 

Step 4 – Figure out what net income (bottom line) you NEED to make and what you WANT to make

The “NEED to make” number will cover fixed costs, whatever the owner needs to take in payroll or draws, and any outstanding debt payments. The “WANT to make” number will take into account savings goals and accelerated debt repayment plans (plans to pay down debt faster).

How to create a small business budget -- table 1

In the “NEED to make” budget, minimum payments are made on outstanding debt, and no money is put into savings.

In the “WANT to make” budget, the owners decide to pay down debt faster, and put the rest of the money into savings plans for operating savings, payroll savings, tax savings, and vacation savings accounts.

To come up with the Revenue and Variable Costs in the “WANT to make” budget, we use the Gross Profit Margin and the amount of Net Income determined by the owners to meet their savings goals.

The owners determined that they wanted to save $50,000 per year in their various savings accounts, and wanted to pay down their debt in half the time they were scheduled to pay it off (5 years vs. 10 years).  They also wanted to “take home” more money themselves for personal goals. We determined they needed to make $153,000 in net income (this is different for each business or business owner) in order to reach those goals.

We create the budget backwards when we create the “WANT to make” budget:

How to create a small business budget -- table 2

This is relatively simple, but it is very easy to mess up on the math, even for people who do this every day. Therefore, I encourage business owners to use this article as a tool for understanding how to create a small business budget, but I do not advocate creating a budget without consulting your trusted accountant advisor.