Small businesses should create and use budgets to do more than simply keep track of their income and expenses. Budgets can help businesses project profits, spot potential problems and opportunities as the year progresses, make adjustments to maintain financial stability and show potential investors or lenders proof of the businesses’ financial potential.
The first goal of a small business budget should be to project how the business will perform financially under a variety of scenarios. Project fixed expenses, such as rent, salaries, insurance premiums and loan payments. Estimate recurring variable expenses, such as utilities, office expenses and Internet costs. Estimate variable costs tied to sales, such as the amount of materials needed to make a product or labor necessary to bring a product or service to market. A budget allows you to compare your costs under several different revenue projections. This will allow you to forecast your material and labor needs as you grow.
After you create the first draft of your budget, plugging in all of your expected costs and comparing those under different sales scenarios, adjust your spending projections to help you achieve a profit.
Determine Break Even
Most small businesses don’t make immediate profits. Once you pay off initial investments in equipment, real estate, extra marketing or other purchases you won’t have long-term, you can estimate when you will start making a profit and how much capital you will need to run the company until it is profitable.
When you know your costs to run your business, you can set the prices for your products or services. A budget helps you identify non-manufacturing costs, such as overhead, debt service, professional fees and other costs you incur. Knowing your exact expenses will help you set realistic prices.
Track Progress and Make Adjustments
A critical goal of budgeting is to create a document you can update and examine each month to see if you are meeting your financial goals. Without a budget, you may not know your income is not covering your expenses until you are deep in financial debt. Using a budget to track your performance will allow you to make real-time adjustments to your business model, rather than waiting until the end of the year.
If you want to attract investment capital, secure loans from banks or obtain lines of credits from suppliers, you may need proof that you are able to pay your bills and debts. Some lenders require only that you secure your loan or credit line with collateral, such as your building, machinery or goodwill. Investors and banks may want to see your business plan, which should include budget projections and your current, up-to-date budget.