“I just don’t “get” the financial part of my business!”
This is a big problem. A problem you better overcome if you plan to enjoy any degree of success in your business, because no matter how many customers you get or how clearly you’re able to build a business around your specific way of helping others, poor financial management almost always means failure.
Just ask Chrysler. Or Pan Am. Or Blockbuster.
Anyway, here’s an overview of how to create a simple budget for your new company.
Budgeting Costs for a New Business
Step 1: Learn the difference between Direct Costs and Operational Costs.
These are called by many names, but the important thing is that you know there are two types of expenses: the ones you only pay if you actually sell anything, and the ones you pay every month regardless of whether your sales are $0 or $500,000.
Examples of Direct Costs: Sales Commissions, Packaging, Ingredients, Shipping. You only pay your staff a commission if they make a sale. You only use up your packaging if you make a sale. You only need more ingredients if you sell the things you made with those ingredients. You only pay shipping if you have to ship something you sold…etc. You get it. Pretty straightforward.
Examples of Operational Costs: Rent, phone, employees, monthly bank fees. These expenses suck money out of your account every month and they don’t care what your balance is. (sniff, sniff.)
Got it? Awesome.
Step 2: Figure out your Direct Costs as a percentage of your sales.
So if you sell a cupcake for $3 and the ingredients for one cupcake are $1 and the packaging is 40 cents then your Direct Costs are 1.40/3.00, or almost 47%.
Another example: You sell a consulting package for $1000 and you have a contractor who performs some of the work for $100 and you also ship a physical workbook to your client, which costs $8 for the printing of the workbook and $5 for the shipping. Your Direct Costs are $100 + $8 + $5, or 113/1000, or 11.3%.
Why is this important? Because then you know how much of your revenue you have left to pay for all those regular monthly costs.
And then it’s way easier to create a budget!
Step 3: Add up your Operational Costs.
This part’s pretty easy – just simple addition of the expenses you know you’ll have every month. Say it’s $1,200 a month.
In our cupcake example above, we only have 53% of our revenue left over to pay Operational Costs (100% – 47%). That’s $1.59 per cupcake. So to get to $1,200 and break even, you need to sell 755 cupcakes per month.
In the consulting example it seems much easier to break even, but it’s also a lot harder to get the clients (usually higher priced products means fewer customers overall). You’ve got 88.7% of revenue to cover Operational Costs, so once you’ve acquired 2 customers a month, you’re in the profit.
What about costs that are only incurred every few months, like marketing?
Glad you asked 🙂
When you’re just starting out, you probably won’t know exactly when you’ll do your marketing or exactly how much you’ll budget for it. So it’s okay to choose an annual amount for your budget, and simply divide it by 12 to get the average cost per month. If you don’t spend your budget in a given month, great – you can roll it over to the next month.
Hopefully, you’re starting to “get” the financials now. Got a question about business plans and budgeting? Drop it in the comments below.