One of the most important tasks the new business owner must tackle is to create a budget for the new company, so you can see expected income and expenses and cash needs.
Since you have no past information to go on, you must create the budget using your best guess on income and expenses (otherwise known as a profit and loss statement). This how-to will focus on business with an inventory of products but it will also discuss a service business with no products.
Before you begin, consider why you need to spend the time to create a budget. Even if you don't need bank financing, creating a budget is still a valuable exercise for any new and continuing business.
Some things to think about before you begin:
- What do you need to open the doors of your business on the first day?
- What will your fixed and variable costs be on a continuing basis?
- What can you contribute to keep costs low (furniture, for example)?
- What can you get as donations from friends and relatives?
- What can you do without (pictures, decorations)?
Keep your "must-haves" to the minimum. The less you need for your business startup, the sooner you can start making a profit.
Step 1 - Plan for "Day One" of Your Business Startup
Begin by determining what you will "day one" of your business, in order to open the doors (or to take your website live) and begin accepting customers.
A "day one" start-up budget can be broken down into four categories (depending on your situation, some of the categories may not apply to your business.) The categories are:
Facilities costs for your business location, including all the costs of setting up a leased location for your store, office, warehouse, or for buying a building. These costs may be called leasehold improvements or tenant improvements. For example, you may need walls or a bathroom or a special secure area in your office or building.
If you are working from home, you probably won't have location costs but you may have costs to fix up a room in your home for an office or a small production area in your garage.
Facilities costs also include lease security deposits and signage.
Fixed assets (sometimes called capital expenditures), for furniture, equipment, and vehicles needed to set up your location and start your business. Fixed assets also include computers and machinery, furniture, and anything for your office, store, or warehouse that is needed to set up your business.
Materials and supplies, like office supplies, advertising and promotion materials. You will need an initial supply of these to get started.
Other costs, like the initial fees to an accountant to help you set up your accounting system, local licenses and permits, insurance deposits, and legal fees to register your business with government entities (like your state) and prepare operating documents.
In your listing of these startup costs, include items you are contributing to the business, like a computer and office furniture. Note the cost of these items in your list so you can get credit for them as collateral for a business loan.
Step 2 - Estimate Monthly Fixed and Variable Expenses
Fixed expenses are costs that don't change and aren't dependent on the number of customers you have. Gather information on your fixed expenses each month. Here is a list of the most common monthly fixed expenses:
- Phones (business phones and cell phones)
- Credit card processing—monthly fees (transaction fees are variable)
- Website service fees
- Equipment lease payments
- Office supplies
- Dues and subscriptions to professional publications
- Advertising, publicity, and promotion commitments, like social media or continuing online ads
- Business insurance
- Professional fees (legal and accounting)
- Employee pay/benefits. (This category is semi-fixed, because you may be able to lower your employee costs at times.)
- Miscellaneous expenses
- Business loan payment
Then add variable expenses. These are expenses that will change with the number of customers you work with every month. These might include:
- Postage, mailing, packaging, and shipping costs
- Commissions on sales
- Production costs
- Raw materials
- The wholesale price of goods to be re-sold
- Packaging and shipping costs.
If you have a service business, you may not need many variable expenses.
Step 3 - Estimate Monthly Sales
This is probably the most difficult part of a budget because you don't know what sales will be for a new company. You might want to do three different sales projections:
- Best case scenario, in which you show your most optimistic estimate for first-year sales.
- Worst case scenario, in which you show your least optimistic scenario, with very little sales during the first six months to a year.
- Likely scenario, somewhere in between. The likely scenario would be the one to show your lender.
To be realistic in your budgeting, you must assume that not all sales will be collected. Depending on the type of business you have and the way customers pay, you might have a greater or smaller collections percentage.
Include a collections percentage along with your estimate of sales for each month. For example, if you estimate sales in month one to be $50,000 and your collection percentage is 85%, show your cash for the month to be $42,500.
Calculate the variable costs of sales for each month based on sales for the month. For example, if your estimated sales for a month are 2,500 units and your variable costs are $5.50 per unit, total variable costs for the month would be $13,750.
Add monthly variable costs to monthly fixed costs to get total monthly costs (expenses).
If you are selling products, you might want to calculate your break-even point to include with your budget. The break-even point shows when you will start making a profit on each sale.
Step 4 - Create a cash flow statement
Cash flow is literally the amount of money going into and out of your business each month.
Managing your cash flow is a key tool for keeping your new business afloat. And cash flow is more important than profits. You can be making a profit on paper, but if you don't have money in the bank, your business won't be able to pay its bills.
Begin your cash flow statement by combining total costs with total collections of money from all sales for each month. Remember that sales and collections might be different, unless you have a cash or credit business. For the cash flow statement, you'll need to use collections.
The monthly cash flow totals should look something like this:
- Monthly sales $50,000
- Collected $42,500
- Total fixed costs $26,900
- Total variable costs $13,750
- Total cash balance $2,150
The $2,150 represents your total cash balance for the month, not your profit.
By changing your sales figures using the three scenarios above, you can see the result in your cash balance at the end of each month. This cash balance can give you information about your cash needs and how much you might need to borrow for working capital.
Tips for Creating Your Business Startup Budget
- Use your accounting software program to create your budget, so you can use existing accounts and make changes more easily. If you don't have an accounting software program, you can use a spreadsheet program.
- Most lenders require three years of cash flow statements on a month-by-month basis, and three years of quarterly and annual income statements (P&Ls).
- Income taxes are a variable expense, and you don't know what taxes you will have to pay until you calculate your net income. Don't include taxes in fixed expenses or variable expenses but make these a separate category.
What You Need to Create Your Budget
- An accounting software program or spreadsheet program.
- Information on the costs associated with the sales of products.
The Most Important Thing to Know about Creating a Business Startup Budget
Estimate sales LOW and expenses HIGH. Everything always costs more and takes longer than you think it will, and it will take longer to get sales going than you think it will.