One of the main reasons why businesses do not succeed is because they run out of cash. This is often caused by them having problems with pricing and costs. This means that their financial management is not as it should be. A business budget can help you to avoid these issues.
What are the benefits of a business budget?
If you are not budgeting in business, you are not laying out the priorities and strategies for your business. It means that you have no idea where your business is going.
- It will tell you how the business is doing right now as compared to where you want to be.
- It can tell you where your business is facing problems and you will be able to address these issues before they become big problems.
- It can help you optimise your marketing strategy. Your budget will tell you when business will be slow and when it will pick up. You can carry out marketing activities based on this data.
- It will help you keep control of your business and make it more efficient.
- It can help you to grow your business because you know where your money is and where it is going. Whenever new priorities arise, you will be able to see the actual situation of your business and determine whether you are able to make use of this new opportunity.
In short, a business budget will help you make good business decisions. Let’s look at how to create a yearly business budget.
1 Write down your yearly expenses
If you have been following this series, you will already have completed this step. But if not, there are 2 key steps that you need to take:
- Start keeping records of your incoming and outgoing money and make sure to separate your business expenses from your personal expenses
It is very easy to forget about certain costs. Maybe because you only pay them 1x per year like your rent or your contribution to a business association. Or maybe because you do not pay them until they appear. Like repairs to your generator, your motorbike or car. Or the purchase of equipment.
Keeping good records will help you to keep track of all your spending. The below example is from a recordkeeping template that I developed for use by small businesses in Africa and other developing countries. As you can see, it also tells you if you did not allocate the expenses in the correct way.
It is important to keep records on a daily or weekly basis to be sure that you do not forget anything. If you have been keeping records for a longer time, you will be able to use this business data to determine your expenses for each month during the coming year.
If you are just starting with record keeping, you can still create your business budget. You will need to guess how much money you will need every month until the end of this year. Then use your recordkeeping to determine if you are correct and adjust as needed.
Whether you just started keeping records or you have been doing so for many years, make sure to review your budget every month. Do this to make sure that your spending is still on course.
- If you have been keeping records for a long time, your adjustments will be few because you already understand your business. However, there will always be unexpected situations or new business opportunities that will affect your expenses. Doing monthly reviews will help you maintain control of your spending.
- If you have just started keeping records, you will find yourself doing more budget adjustments based on the data you are getting from your recordkeeping. For example, your record keeping may show you that you have forgotten about certain expenses. Or it may show you that certain expenses are less than what you estimated in your budget. This is not a problem. The important thing to get this information so that you can maximise your business growth.
2 Create your sales forecast
Another reason why businesses fail is because they overestimate the amount of sales they will make in a year. When you start keeping track of your sales and using a budget, you will be able to make adjustments when you see your sales falling off target. You will also be able to determine whether it is a normal seasonal effect or whether you should take action.
This is why good recordkeeping is the number one rule in good business management. Good recordkeeping will give you business data that you can use to determine your goals and your business strategy. This will then also determine your business success and growth.
When you are estimating your sales, try to use data from last year. Using the actual business data will help you to set realistic and achievable goals.
Look at your records to see how much you sold in each month and use that information to determine how much you will sell during each month this year. At the very least, you should be able to match what you sold last year. I recommend that you try to increase your sales a little bit each year, maybe add 10% every month. Note: you will also need to have a strategy in place to then be able to increase your sales!
If you do not yet have business data from recordkeeping, just estimate your monthly sales for now. And then use your recordkeeping to check whether your estimate is correct. If not, adjust as needed.
We talked about how to calculate your sales forecast a few weeks ago. The below example is from a sales forecast template that I developed for use by small businesses in Africa and other developing countries.
3 Calculate your gross profit
Your gross profit will tell you whether the product (or service) you are selling is profitable. Note: your gross profit does not equal your actual (net) profit!
Your gross profit should be enough to cover all your direct business expenses and leave enough money to cover your indirect business expenses + personal or family expenses. We talked about how to calculate gross profit 2 weeks ago.
What are you seeing? Does your business have a positive or negative gross profit?
- If you have a positive gross profit, that is great! You can move on to the next step and calculate your net profit or loss.
- If you have a negative gross profit, you need to take action. A negative gross profit means that your selling price is not high enough to cover the cost of producing or selling your products. Or, that the cost of producing the product is too high.
To address this issue, you should consider increasing your selling price or reducing the cost of producing your products. One way to do this is to negotiate discounts from your suppliers. You should also look for ways to start selling products that have a higher price while maintaining your direct business expenses.
How to negotiate with suppliers as a small business
Try to get discounted rates, for example by buying in bulk. If you are not able to buy in bulk, try to reach an agreement about getting a discount after you have bought a certain amount. Use tiers. For example: get a 10% discount from your supplier after you have bought a certain number of items or spent a certain amount. And get another 10% discount if you reach the next level. Keep track of your purchases so that, if necessary, you can prove to your supplier that you reached this number or amount.
4 Calculate your net profit or loss
Your net profit is the actual profit that your business is making. This is the money that you will use to build financial reserves, to invest in your business, and to cover personal and family expenses.
To calculate the net profit, subtract your indirect expenses from your gross profit. If you pay taxes, don’t forget to take them into account. Are you making a loss? It means your indirect expenses are too high. Try to reduce your costs.
See this example from a Profit & Loss template that I developed for use by small businesses in Africa and other developing countries.
5 Create your business budget
Put the above information together and you will have created your business budget.
See this example from a Business Budget template that I developed for use by small businesses in Africa and other developing countries.
Don’t forget to track your progress to see how your business is doing. If we look at this example from my Business Budget template for small businesses, we can see that this consulting company is falling behind schedule.
The Full Year overview is telling the business owner how far they still have to go. At the same time, the Year to Date overview is telling them how far they have come as compared to where they should have been by now. The business owner can now use this data to take action.
For example: under Year to Date, we see that Revenue and Profit have fallen behind schedule, but Expenses are higher than they are supposed to be. This is not good, because if your sales are less than expected, I would also expect to see lower expenses.
This business owner will therefore do 2 things:
- Review the expenses to determine why they are higher than estimated.
There may be a good explanation for this. If so, the business owner should adjust their budget to reflect this new data.
However, it is also possible that the business did not control their spending well. In that case, the business owner will keep tight control of spending in the coming months and seek to reduce all expenses as much as possible.
- Take action to increase sales.
Maybe by increasing marketing activities, for example by doing additional marketing on social media or in the community. Maybe by giving discounts to encourage customers to buy more products. Maybe by finding ways to attract new customers.
It is also possible that the business owner made a mistake in the sales forecast. Meaning that they estimated higher sales but are now seeing that they need to make adjustments. In that case, the business owner will adjust the budget to account for the lower sales forecast. Of course, my advice will then be to look for ways to increase sales while also finding ways to reduce expenses!
So, you see now how having a budget can help your business prosper.