Creating a business budget can appear intimidating at first. Budgeting can be very complex, especially if you are just starting your business. Knowing the essential elements of a budget will help you decide how you will divide up your resources and handle your costs and expenses.
Most businesses have an overall budget which is called the master budget. The master budget is divided into two parts. The operating budget is associated with the income-generating activities of the firm like sales and production. The financial budget includes information about the company will acquire cash in the future and how it will spend that cash. The financial budget is generally the last budget developed in the company's budgeting process.
Here are the items from both the operating budget and the financial budget that are major considerations for a business owner when developing the master budget.
Before you can think about any other line item on your business budget, you have to consider how much money you anticipate making. If you are starting up a new business or if you see changes in your current business, set sales goals that reflect your current business circumstances.
You want to determine your sales goals before you start your business or change your business model so that you can accurately calculate how many units you may need to produce and sell or how many clients you need to have.
A key to determining your revenue is to figure out your pricing strategy. Initially, you'll have to find a competitive price by conducting market research to find your competitor's prices for the same product or service or a similar product or service.
After operating for a year or more, you will be able to conduct a financial analysis and determine some key indicators of pricing, such as product contribution margin or sales volume variance.
The contribution margin tells you the profit each unit generates and can help you establish your break-even point, which tells you the minimum amount of units you need to produce to break even.
The sales price variance is the change in expected revenue from sales. In other words, it is the difference between the budgeted sales price and the actual sales price.
Production Volume and Cost
Once you have your desired sales revenue, you can begin to determine the number of products or services you need to sell to make your revenue goals. The costs of production for your services or products will allow you to see if you have set your revenue goals too high or too low.
Production volume is the number of units a business has to produce to meet it's sales goals. It is also the total amount your business can produce in a period.
Production costs are the costs that are directly related to the production of goods or services. Examples of production costs are materials, labor salaries and wages, and factory overhead (if your business is a factory.)
Factory overhead comprises the costs related to production which are not spent on what you are producing. Examples of this could be salaries for the floor manager or the cleanup crew.
Work on balancing your sales revenues and production costs until you find the combination that works for you.
Take stock of your operating expenses. There is a large list of operating expenses that depend largely on your industry. Some examples are office-related expenses, salaries or compensation not related to production, and sales and marketing expenses.
Office-related expenses are expenses such as legal fees, office supplies, and office utility costs. You may hear some of these expenses referred to as selling, general and administrative expenses (SGA).
Some sales and marketing expense examples are advertising or client entertainment costs.
Determine how much cash you have and how much you'll need to have. Cash or cash equivalents allow you to pay your expenses. Cash equivalents could be money market securities. A cash budget will be your best tool.
Cash flow statements allow you to view where your cash is going. With an understanding of your cash flow, you can look at your cash position with regard to operations, investments, and financing activities.
The capital expenditures budget deals with buying fixed assets for your small business. Fixed assets primarily include your plant, or buildings, and your equipment, such as machinery you own. Instead of purchasing your fixed assets, you do have the option of leasing them. Typically, a small business minimizes its capital expenditures as much as possible since they tend to be expensive.
A small business needs to have an emergency fund set aside in the event of unexpected expenses. Unexpected expenses can sink a small business unless you plan for them.
An emergency expense example is storm damage to your facilities. Damage from storms may be covered by your insurance, but you will have to be able to pay any deductibles and for anything not covered by the insurance policy.
Emergency funds are usually placed into the category of retained earnings on your balance sheet. Retained earnings are revenue that is kept after all expenses and liabilities are paid.
You may want to consider having a sub-category of your retained earnings for emergency funds and keep these funds separate from other earnings so that they will not be spent.