What’s it going to cost to run your business this year?
What’s that? You don’t know?
Well, that’s a problem.
If you’ve been operating for at least a year, you might be inclined to assume it’ll cost the same to run your business this year as it did last year. But that’s a dangerous assumption. Your service providers probably increase their prices every year. The online tools you use might cost more when you renew your subscription. Or maybe your business is set to grow this year (yay!) – in which case, your expenses are definitely going up.
Perhaps you’re not in business yet but you’re planning to start this year. Lucky you – you have TWO budgets to do! If you have no idea what your business will earn or what you’ll be able to afford, budgeting is even more important; the focus is just a little different.
No matter how long you’ve been running your business, an annual budgeting exercise is essential to your company’s health. Oddly we often avoid it because we don’t like to think about expenses. Entrepreneurs (and I’m guilty of this too) tend to focus too much on top line revenue and not enough on understanding their expenses so they can see when they actually begin to profit. Sure, it takes a little more analysis, but it’s really not that hard and it’s SO essential for understanding how well your business is performing.
So let’s take a look at how to develop a start-up and an operating budget for your business. The key here is to be realistic, not dreamy. Be conservative about your revenue expectations and add some contingency to your expenses, and make the budget work.
THEN CRUSH IT. And celebrate your higher-than-expected profits at the end of this year!
How to Create a Start-Up Budget
(Already in business? Just skip to the next section)
A lot of people ask me how they can possibly create a start-up budget when they have no idea just how big some of their major expenses will be. The trick to figuring out what it’ll cost to start your business is to avoid focusing on the numbers.
Let me explain.
First, we have to define a start-up budget. The start-up budget is ONLY the money you have to spend before you ever open for business. So it might include a rent deposit, but not your actual rent. Maybe wages for training, but not salaries. Make sense? Great.
The trick is to figure out what you need to spend money on, before worrying about the actual cost. So start with line items. What are the essential start-up costs? Things like:
- Business registration and a license
- Website development
- Pre-launch advertising
- Equipment and inventory purchases
That sort of thing. Keep writing things down until you’ve exhausted that list. Thought of everything? Okay, now it’s time to start adding numbers to each line item.
Begin with the easy stuff. It’s easy to find out exactly what a business license costs – just go look it up on your municipality’s website.
Once you’ve nailed down all the precise numbers you can, it’s time for some research. Need tools for your framing business? Call a couple of places that sell contractor-grade tools and get a written quote. If you have to renovate a space for a storefront, get at least two people to give you quotes (do this EVEN IF your brother is “taking care of it for you” or you “know someone”. Friends deals often fall through, so you need to know you can afford a backup plan).
If you just can’t nail down a reliable number, include a range, or make two budgets – an all out, everything and the kitchen sink budget, and a bootstrapper’s budget with just the essentials.
Got your list? Add up the total and see if the number scares you. If it does, then look at what you could cut. But here’s where you have to be a bit careful; you should never eliminate an unavoidable expense (like legal fees or permits). You should also consider what experience you want your customers to have when they first encounter your business and don’t cut any expense that might jeopardize that experience.
For example – let’s say you’re opening a retail store with curated high-end products designed for contemporary homes. You wouldn’t want to build your display shelving out of plywood and screws just to save a buck, would you? The type of customer you’re targeting would see right away that you cheaped out on finishings, and wonder if your products are low quality, too. Don’t threaten your brand from the beginning. Spend money where you need to, but shop for deals on the essentials if you have to.
Of course, you probably won’t spend your whole start-up budget at once; you’ll progress towards your grand opening over several weeks or months. Keep careful track of your actual spending to see if you’re on budget. Wherever you save money, you can increase your budget in other areas.
Here’s a Hot Tip
Open a business bank account as soon as you register your company so you can keep track of your spending more easily. I promise it’s harder to separate your personal expenses from your business expenses than you think it is. So do it right from the start. Your bookkeeper will thank you!
How to Create an Operating Budget
Your start-up budget is one thing, but the minute you launch your business, you also have to contend with operating expenses. If you don’t know what it costs every month just to keep the lights on, you could run out of cash before you’re bringing in enough revenue to cover your costs!
So, you need a budget forecast – at least for your first year, and longer if you’re going for any external financing. If you’re in business already, lucky you! You can start with last year’s expenses and review them to see how they’ll change this year.
Fortunately, the process to create an operating budget is similar to creating a start-up budget:
- List all the costs of running your business (without any numbers attached)
- Add actual costs (in dollars) for the fixed expenses you know about (like rent, which should be the same every month)
- Add estimates for the costs you don’t exactly know
To budget expenses that only happen once or twice a year (like an insurance payment, or conference travel), you can simply average them out over 12 months if that makes it easier to determine your average monthly costs. We’re not doing a cash flow analysis (yet), so the timing of the expenses isn’t relevant; we’re just trying to figure out how much, on average, you’ll be putting out every month to stay open.
Once you know this number, you also know your break-even point – that is, the revenue you must bring in every month to cover your operating expenses.
You don’t need a fancy tool for this; a simple Excel spreadsheet will do.
But What about Cash Flow?
Having a budget is great, but timing is everything when it comes to staying on track with your business spending. If you have too much money going out before money comes in, your business can get into deep trouble fast. And we don’t want that!
That’s why it’s important to understand cash flow – the timing of money coming into and flowing out of your business.
Ever been short on money or had to get a payday advance because your rent was due before payday? That’s a cash flow problem. Yes you earned enough that month to cover your rent, but because of the timing of your expenses, you ended up temporarily in the red.
But if that happens in your business, you’re out of business. Fast.
So consider the way you collect money. If your customers pay 100% of their purchase on the spot – like at a restaurant – great. But even then, you have to wait a couple of business days for credit card transactions to clear, so there’s still a lag.
It’s crucial to stay aware of not just how much money you earn, but when you actually collect it and make sure there’s always enough in the bank to cover you until you get paid for real.
Don’t Be Afraid of Numbers
If you want to be a successful entrepreneur, finances need to excite you, not scare you. You don’t need to become an accountant, but you do need to be confident about what level of spending you’re comfortable with. If you remember that a budget is a tool and a guide – and you don’t have to freak out if you can’t follow it exactly – then looking at your expenses becomes an empowering exercise, not a chore or a burden.
The key is to understand what you need to spend money on first – and then build actual numbers into your budget. This helps you avoid throwing up your hands in frustration because you don’t have exact numbers to work with.
One more hot tip: you should make every business spending decision with your customers’ best interests in mind.
Don’t make spending choices based on fear (fear of spending too much, fear of not getting a return on investment). There’s a simple way to make better choices about business expenses: when you’re struggling about whether to buy something, ask yourself: will this improve the experience for my best customers?
If not – slash it or eliminate it.
Now get to some number crunching!
Got a budgeting question? Pop it into the comments. I’ll answer every single thread.