Think back to the last road trip you took. Did you hop in your car and drive off, wandering aimlessly from city to city? Of course not! You intentionally chose a destination and carefully planned your route before heading out.
Running a business is a lot like a road trip. First, you need to decide where you want to go. Trying to run a business without a clear strategy is like traveling without a destination, so where do you want your company to be in the next 12 months? Do you want to increase sales, decrease expenses, hire more employees, or invest in new fixed assets? By figuring out your overall goals, you can determine your journey objectives.
Once you know your destination, you need to chart your course. You won’t ever reach your target if you don’t have a plan to get there. And if your business goals are your destination in this analogy, your budget is your map. It is the tool that will show you how to get where you want to go, as well as tell you how you are progressing during the year.
How to Build an Effective Business Budget
Does the thought of creating a budget for your business feel overwhelming? Do you know you need one but wonder where to even start? A business budget can seem daunting, but by following the steps below, you can create a detailed map that will lead you to your business objectives.
1. Start with your monthly Profit and Loss (P&L) report
The easiest way to start a business budget is by using your monthly Profit and Loss (P&L) report from the last 12 months. Download this report to Excel, then duplicate all monthly columns as if your new year’s budget was the same as last year’s actual activity, keeping last year’s data as a reference. This will be your starting template.
(Note: some people find it easier to start with an annual budget and only break it down monthly once all numbers are finalized. This is a matter of preference, however, and either way will work.)
2. Adjust as necessary
Review each account line by line, changing the amounts for the new year’s budget in accordance with your overall goals. Be sure to consider whether other accounts might be affected by any changes you make. For example, hiring a new employee will increase wages, payroll taxes, benefits expense, and worker’s compensation insurance, as well as new equipment expenses.
3. Make detailed notes
As you craft your budget, leave sufficient notes on each line so you remember how you derived each number. You will likely not remember, for example, whether each budget variance over the course of 12 months was caused by inaccurate budgeting or intentional overspending (and if so, the reasons for it), so these notes will be invaluable later when you compare your budget to actual reports.
4. Don’t forget your taxes!
As a final tip, be sure to add a line at the very bottom of your budget for income taxes and self-employment payroll taxes. Keeping this in your budget will help you save for these critical (and oftentimes large) cash outflows.
Watch Out For These Budgeting Blind Corners!
As with any road trip, there are blind corners to watch for when creating your budget. Be mindful of the following potential pitfalls when creating your budget:
Blind Corner #1: Overlooking cash flows that aren’t in your P&L
Some items affect your cash balance but don’t affect your P&L – they show up on your balance sheet, instead. I recommend listing these in separate rows below your net income line in Excel (after the tax line you just created) so you can determine your net cash gained or used.
For example, fixed asset purchases use your cash but don’t show on your P&L as an expense. The same is true of bank loan payments. As you pay down the loan, the principal portion uses your cash, but doesn’t show up on your P&L as an expense. A third example is personal expenses. If you pay personal expenses out of your company, you should record them as Owner’s Draw (in the equity section), which reduces your cash but doesn’t show up on your P&L as an expense.
Blind Corner #2: Misinterpreting high cash balances
Whenever you see a lot of cash built up, it’s easy to think you have the means for a spending spree. You need to remember, though, that you may need that cash to buy planned fixed assets, pay down a loan, pay your taxes, or even provide security for an unforeseen pandemic! You probably already have a plan for that money, you just haven’t written the check yet, so always refer to your strategic goals and budget before using that “extra” cash.
Blind Corner #3: Spending all your revenue every month
Whatever you do, don’t allow your company to live “paycheck to paycheck.” If we’ve learned anything over the last 18 months, it’s that you never know what the future holds, so you need to prepare for unexpected business fluctuations or slowdowns. The companies who survived 2020’s pandemic had a solid cash balance, and you should, too.
Discipline is your fuel
Finally, if your strategic plan is your destination and your budget is your map, discipline is your fuel. You need all three for a successful journey! And just as a map won’t magically take you to your destination – you have to choose to follow it turn by turn – if you want to achieve your goals, you need to develop the discipline to stick to your budget. Every month. Every day.
Of course, that doesn’t mean there won’t be detours along the way, so there may be times you need to adjust your route mid-journey. If you are considering an unbudgeted purchase, take time to review your strategic plan and how that purchase fits into it. Does it support your overall goals? If so, how will you increase revenue or cut other planned expenses to allow for it? If not, are you absolutely certain you want to make that purchase?
These are questions you need to thoughtfully answer any time you are considering veering from your route. Without the proper adjustments, even slight deviations could prevent you from reaching your destination. With a detailed map in your hands and your sights set on your objective, however, you will be well set up for a successful journey.
The tips above should give you a solid starting point for crafting an effective business budget. If you need further help, or you would feel more confident with expert support guiding you through the process, I would love to be of service! I’ve helped many businesses successfully create the map they need to take their company where they want it to go. If you would like to be one of them, give me a call or book an appointment today!