The Green Sheet Online Edition

October 25, 2010 • Issue 10:10:02

Budgeting: A crucial management skill - Part 2

By Vicki M. Daughdrill
Small Business Resources LLC

Establishing a budget and adhering to it isn't easy, but it's the best way to make sure your money goes where you need it to go. As I mentioned in "Budgeting: A crucial management skill," The Green Sheet, Aug. 9, 2010, issue 10:08:01, creating an annual budget, like any management activity, requires time and effort.

However, if you invest the time to create a comprehensive and realistic budget, you can manage your business more easily and more effectively. Once completed, your budget can help you control your expenses so that you spend money in predetermined ways, generate sufficient income to cover your expenses and make a profit, and assure that you attain your business objectives.

It is important to create a realistic budget, one that you can follow. A budget is a flexible document that can be amended as needed; however, if you do a good job developing your budget using practical, down-to-earth figures and assumptions, amendments and adjustments will be few and far between. This article provides a step-by-step guide to assist you in creating your budget.

Gather information

Here is a list of information you will need to help you plan and organize your income and expenses for the coming year.

• Copies of the previous year's bank statements
• Copies of the previous year's credit card statements
• Invoices for items purchased for resale
• Copies of lease agreements, utility bills, payroll figures, insurance statements
• A detailed list of all sources and amounts of income
• A list of all expenses, providing as much detail as possible
• A list of all tax payments along with the due dates

Set your direction

Think about the direction you want your company to take. Make a list of your values. Write down what is important to you and how you want to conduct business. Then prioritize items in order from most to least important. For example, is it more important to provide top quality service to your customers than it is to have the greatest possible number of sales?

Write down your goals

Consider what you want to accomplish financially, formulate your goals and write them down. Then determine the steps you will take to attain them. (For more information on setting goals, see "Dreams fulfilled: Six easy steps," by Jason Felts, The Green Sheet, Dec. 22, 2008, issue 08:12:02.)

Project your income

Identify your sources and levels of income from previous years. Evaluating the current economic climate, determine if projected sales for the coming year will likely remain flat, increase or even decrease. Be realistic. Remember, you want to project your income conservatively. Being overly optimistic can make your entire budget inaccurate almost immediately, and you will need to modify it to reflect actual income.

Evaluate your expenses

There are two types of expenses: fixed and variable. According to Wikipedia, "fixed costs are business expenses that are not dependent on the level of goods or services produced by the business and that do not change as a function of the activity of a business, within the relevant period. For example, a retailer must pay rent and utility bills irrespective of sales."

Examples of fixed costs include:

• Rent or mortgage payments
• Utilities
• Telephone service
• Website registration, maintenance and updates
• Loan payments
• Lease payments
• Dues and subscriptions
• Advertising
• Business insurance
• Accounting fees
• Office supplies and expenses such as postage, stationery, etc.
• Payroll expenses, benefits and taxes
• Auto or travel expenses

Wikipedia defines variable costs as "expenses that change in proportion to the activity of a business. Variable costs are sometimes called unit-level costs, as they vary with the number of units produced."

Examples of variable expenses include:

• Raw materials
• Items purchased for resale
• Hourly wages
• Commissions
• Packaging, mailing, postage and handling charges

Remember, in budgeting expense items, it's better to overestimate than underestimate.

Assess your profitability

Once you've reviewed your income and expenses, determine if your projections will allow your company to make a profit. If you need additional profit, adjust your budget by both increasing revenue and decreasing expenses. The equation will not work unless you complete both activities. Here are some suggestions to help increase revenue:

• Increase the number of units sold.
• Increase the profit margin (the difference between what the unit costs to acquire and how much you sell it for).
• Diversify your product offerings: offer something different, unique or an add-on.
• Cross-sell with other products.
• Step up customer service. Satisfied customers lead to referrals and more customers

Once you've adjusted your revenue figures (remembering to keep them realistic and conservative) look at your expenses. Begin with the fixed costs. Determine if there are ways you can reduce them. Here are some ways you may be able to slash fixed expenses:

• Question how much you spend on rent. Ask if you can rent a smaller place, negotiate a lower rate, or eliminate this expense completely and work from a home office.
• Conduct a thorough assessment of your insurance and tax records. Discuss ways to reduce your tax liability with your accounting professional, and ask your insurance agent to help you determine if your insurance coverage is necessary and, if so, whether you are paying the lowest premiums possible.
• Meet with your banker to consider refinancing some of your debt into lower interest rate instruments.
• Evaluate your staffing needs. Can any tasks be outsourced to independent contractors to help lower payroll and benefits costs?

Next, review your variable expenses. Since these expenses are directly related to the number of items you produce or sell, you have more control over them. For example, you can aggressively shop the prices of items you purchase for resale and negotiate a favorable pricing structure; if sales are lower than projected, you can eliminate part-time workers; or you can seek more efficient, less costly ways of shipping or delivering merchandise.

Create your budget

Once your evaluation and assessments are complete, draft your budget document. Numerous products exist to assist you with establishing a budget document, including:

• Accounting software such as Peachtree and DacEasy from Sage or Intuit QuickBooks
• Spreadsheet software such as Microsoft Excel or OpenOffice Calc
• Printed books and guides pertaining to business budgets
• Internet searches using terms like "creating a budget" or "business budget"

Here are some final tips to keep in mind as you create your budget:

• Use figures from prior years only as a starting point. Remember, the economy is different each year, so your figures will change each year, too.

• Create a realistic budget that you can follow. It is pointless to create a budget that is not grounded in fact and reality.

• Find a system that works for you. It can be a complex computer software package or a simple pencil and columnar pad.

• Look at industry standards for your type of business. These guidelines can help you determine if your figures are in line with similar businesses.

• Evaluate your budget regularly. If your income is lower than projected, the earlier you adjust both your income and expense figures, the more likely you will be to achieve the profit goals you set when you began the process.

Good luck as you draft your budget for fiscal year 2011. It will be another challenging year for small businesses, but this important tool can help you realize your professional dreams.

Vicki M. Daughdrill is the Managing Member of Small Business Resources LLC, a management consulting company. E-mail her at vickid@netdoor.com or call her at 601-310-3594.

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