Budgeting is arguably the least exciting and most important aspect of creating a company. This step forces you to think about how much you’re not only making but also all of the things your spending money on.
Budgeting is also useful because it’s going to give you an idea of what your business can do on a month to month basis. By effectively managing not only your cash flow but also things like your team and paying attention to the market, you’re in you better your chances of success.
This article can be thought of as being two distinct parts. The first one covers how to make a budget for a startup. It covers
- Figuring out your expenses
- Fixed vs. variable costs
- Figuring out your income
- Estimating Your cash flow
The second part of this article is more focused on common mistakes people make while creating a budget. This is so that you are aware of things that often cause business owners losses, and potentially cost them the company. This section touches on
- Trying to go it alone
- Not knowing who your target audience is
- Overspending when starting out
- Not having SMART goals
Figure Out All of Your Expenses
Before focusing on how much you can rake in, try to figure out what are all of the things that are costing you money. Your expenditures will come from one of three categories.
- Facility Costs
- Fixed Assets
- Supplies Expense
Regardless of if you’re operating a small coop, or out of a warehouse, businesses will have to buy, or rent their space. In addition to the physical property, they’ll also have to spend money on things such as:
- Project costs
- Infrastructure costs
- Ongoing costs
Project costs come from when you’re adding to the existing space. This can include building additional walls, to create a functional space or adding more bathrooms. Project costs can also be related to expenses from working with architects, engineers, and draftsmen.
Infrastructure costs are like project costs, but they arise due to increased demand. If you need to increase the size of a parking lot or add to an existing space, so you can have more merchandise on the sales floor, these would both be infrastructure-related costs.
Ongoing costs are also known as recurring costs, and these are fees that result from continual use of space. Maintenance costs, insurance, landscaping, and property taxes all fall into this category.
These types of costs are furnishing and anything item that will lose value over time. You buy these because they have a long lifespan, and help your business. Examples of fixed assets are rent, production and office equipment, furniture, plants, and depending on your business vehicles.
Also known as materials and supplies, these items will either be a factory or an office supply. Factory supplies are things like raw materials and goods, cleaning supplies, and maintenance supplies, and are associated with the production area or upkeep of a business.
Office supplies are things that are inexpensive and commonly found in an office — items like staples, printer paper, and ink cartridges.
In addition to factory and office supplies, anything developed for promoting your business is considered a materials and supplies expense. However, it’s not considered to be apart of either subcategory.
Estimate Fixed and Variable Costs
This is an important step when planning your budget because fixed and variable costs are subtracted from the businesses collected income to determine how much cash you have on hand.
Fixed Costs are those that are not dependent on the size of your team, or how much traffic your store sees, or how busy your company is if it’s a service provider. There are a large number of things that can be fixed costs, but some of the most important ones are
- Business loan payments
- Rent and utilities
- Credit card processing
- Legal and accounting fees
- Various forms of insurance
Variable Costs are those that are dependent on not only the size of your team but also how business is doing. Examples of variable costs include:
- Cost of raw materials
- Shipping and handling fees
- Production costs
- Wholesale costs of goods
There was one thing we didn’t classify, and you should be asking is payroll fixed or variable? Well, that’s dependent on your business. Team members who earn a salary are a fixed cost, because you have to pay them a certain amount, and they have a set number of hours.
Team members who work hourly, are considered a variable cost; if the business is doing poorly, you can schedule them for fewer hours. The flip side of the coin is that if a business is booming, you can give them more hours.
Hourly workers give you flexibility, and when you’re starting a business that important, especially when it comes to your bottom line.
Estimate Your Monthly Income
Determining your monthly sales is one of the hardest parts of creating your budget, which is why we recommend making three instead of one. The first one should be your projected sales amount for your best-case scenario, the second the expected sales in a worst-case scenario.
This is, so you know where your peak and valley will be. The estimated sales that you use should be somewhere in the middle because that’s the most likely scenario. When creating your budget rather than using sales, consider using your gross projected sales multiplied by a collection rate, to have your adjusted income.
What is a Collection Rate
A collection rate is the percentage of payments for services rendered and goods sold that have been collected. This amount is often not 100% because there is some loss due to people owing money, defaulting on their payments, or payments being made late.
It is worth mentioning that a collection rate rather than be calculated month to month is calculated out of a 12 month period.
- The adjusted collection rate is when you divide payments by charges
- Payments are money that you take in
- Credits can also be refunds, but it’s money given back to various customers
- Charges are how much money you are supposed to collect
- Contractual Agreements can be a variety of things, if something is written off or if the charge is forgiven if someone defaults on their debt. Late payments are also factored in here.
For this example, you’re a dentist in West New York with your own practice. Let’s say in your first year you’re projecting to bring in $1,500,000 worth of items in your first year of operations. The company has to give $15,000 back to various patients through refunds and credits.
Since you are a service provider instead of a store, your charge amount is $1,850,000. However, you have to write off $300,000 due to people defaulting on their payments, or refusing to pay for services rendered.
Using this formula you have:
When you plug this into a calculator, you have an adjusted collection rate of 95.8%. This number becomes important because as an additional way to calculate your budget.
Rather than say you’re going to bring in $1,500,000, say your income will be your projected income multiplied by your projected adjusted collection rate, in this case, $1,437,096. Divide this number by 12, and that is your estimated monthly budget, $119,758.
It’s worth mentioning that you can also use this formula if you are a store owner, as opposed to a service provider, there are three things to keep in mind.
- The amount you give as a credit will be higher because you’ll have to refund the cost of items that don’t work and expired products.
- Your collection rate will be closer to 100% because if your selling goods, you shouldn’t have outstanding accounts
- You will have losses to factor in because your store will experience losses due to shoplifting. This amount comes out of your total profit, and it’s hard to estimate.
Don’t Undervalue Your Product
We can’t stress this point enough. If you are a craftsman or produce a large number of pieces, there’s an inherent cost for each item. Let’s say on the side you paint, and you decide to sell some paintings, and also take requests.
You can paint 10 paintings a month, and on average, each costs you $40 to make, and you make an average of $100 a painting. You end up netting $600, which is a nice bit of play money.
However, what if the market supported an average of $150 a painting, and you didn’t know you could charge that much. Your new net earnings would have been $1,100, but because you were charging around $100 per piece, you missed out on $500.
Undervaluing your product is like owning a bar that overpours drinks, you end up losing a lot of money. By knowing the amount, the market is willing to pay for your good, at different times of the year, this can better your business’s chances of turning a profit.
Create an Estimated Cash Flow Statement
Your cash flow statement is going to be the difference between your gross income, and the cost of fixed and variable costs. It’s important to note that this isn’t your profit; this is the amount of cash you’ll have on hand, after a certain point in time.
If you own a small store we’re going to say your first month looks something like this :
- Monthly sales $50,000
- Collected $49,500
- Total fixed costs $27,900
- Total variable costs $18,750
- Total cash balance $2,850
The $2,850 represents your total cash balance for this month. From here, you’re going to add or subtract your monthly cash balance to your previous month’s balance, and that tells your total amount of cash on hand.
A negative balance means that you’re losing money. You may need to think about cost-saving measures or charging more for your goods to make up for money your losing.
Common Mistakes Make While Starting a Business
This section covers 4 mistakes that are commonly made when starting a business. Although they indirectly impact your budget, they still affect it in big ways. You should be mindful of these four things to better your chances of successfully operating a new business.
Trying to Go it Alone
Although the phrase “Jack of all trades” is often used to talk about owning a business, we often forget to include the second part, “is a master of none.” Rather than try to do everything yourself, don’t be afraid to delegate.
You can hire an accountant to help with your finances or writing companies to help you add regular content to your companies blog section. Also, you can invest in a marketing firm to help you figure out your target demographic and a solid ad campaign.
Play to your strengths, and take advantage of delegating, so you can focus on parts of running a business that you’ll excel at.
Know Your Target Demographic
This is important because it directly impacts your marketing strategy, and you could be wasting money by creating an ad campaign for the wrong people. If your target demographic is teens and young adults, for example, your ad material is going to be featured on social media such as Facebook, Insta, and Snapchat.
However, if you’re targeting an older audience, you’re going to move offline. The best place to reach these people is TV commercials, radio, and print ads.
Rather than get the most expensive equipment, software, and marketing team, go mid-table when you open. This will save some of your startup capital, and when you start turning a profit, you can reinvest that money into upgrading pre-existing infrastructure.
Setting SMART Goals
Smart Goals are great because there, Specific, Measurable, Attainable, Relevant, and Time-Based. An example of a SMART Goal would be reaching selling $100,000 worth of goods in your first month of operations.
- It’s Specific because it’s well defined, we know what the person is trying to do
- This is a Measurable goal because there is a monetary amount and a time component.
- It’s also Attainable because a business selling $100,000 worth of merchandise is roughly $3,300 worth of goods sold a day
- Depending on the market, this may be a Relevant goal, meaning one that makes sense; however, if the market is highly contested, this goal may not be Attainable
- Time-Based, going back to Measurable, the time component for the goal listed is one month. It’s worth noting that things tasks with a time component are more likely to be completed.
According to the Small Business Association, 20% of all businesses will fail in the first year. By following our tips when it comes to making a budget, sticking to your budget, and avoiding mistakes commonly made in year one, you’ll be able to thrive.
This will help set you up for success, and even though 80% of all businesses make it to the one-year mark, half will close their doors before their 5th anniversary. The trick to lasting once you establish yourself is going to be focusing on changes in the market because the market will dictate consumer behaviors.