A small business budget is like a treasure map. Yup, you heard that correctly. Just think of Jack Sparrow in the Pirates of the Caribbean.
Many entrepreneurs and business owners can communicate where they want to be at some point down the road. For many, that is obtaining the treasure i.e. achieving goals and financial measurables.
But they struggle with how they are going to get there.
That’s where creating a small business budget comes into play. Think of your small business budget as the map to provide the steps to obtaining your treasure.
At New Economy, we believe in one-year, three-year, and 5-year budgets, and as we are entering into the fall, now is the time to start thinking about your budget again. As much as we love the three-year plan, this article is focused on the one-year plan.
We want to help you gain control of your finances to make smart decisions to build and grow your Company.
In this article, you will learn about:
- How to get started on preparing your one-year small business year budget
- Best practices in creating your one-year small business budget
- Utilizing your one-year small business budget to obtain your treasure
- 3 key takeaways
Let’s dive in.
How to Start Preparing Your One-Year Small Business Budget.
You might be surprised, but some of the most important parts of creating a budget have nothing to do with numbers or spreadsheets. The first part of creating a budget requires stepping back and obtaining a deep understanding of the business.
Understanding the Business
At New Economy, before we prepare a one-year budget, we spend time getting to know the business. This requires meeting with key team members like the Visionary/CEO, Integrator/COO, Operations, and Sales team leaders in an effort to gather as much knowledge as possible about the business.
We do this because we seek to understand. We want to be able to offer up best practices and strategies to help you get closer to achieving your goals. And without historical context, an understanding of the present moment, and the future vision it is difficult to predict.
Here are some of the things we seek to obtain and understand and what you should too if you are preparing your own budget:
- Review existing business and financial information like historical financial statements, tax returns, and business plans.
- Review and understand unit economics. For example, the cost of making your product or service.
- Review pricing strategies.
- Understand management’s vision, growth, and exit plan for the business.
- Get a sense of the resources needed to achieve the vision. Think people, equipment, technology, and so forth.
- Understand the finances and capital in place to support the business.
- Understand the sales and marketing process and review all collateral.
- Understand the issues and challenges the business is facing.
- Get a sense of the overall market conditions and opportunities in the specific industry.
- Review key documents like customer agreements, employee agreements, and bank documents.
It seems like a lot and it is, but it’s important. We typically have a few sessions to do these knowledge and data transfers.
By reviewing all of this information, we are able to obtain a baseline understanding of the business and the direction that management is looking to go. We use this as the foundation for building a one-year small business budget. So don’t rush through, take your time and seek to understand. Soon, you’ll have what you need to create the map that leads to your treasure.
Best Practices For Creating Your One-Year Small Business Budget
Okay, now we are ready to get started.
Tools and Technology
There are many forecasting tools out there, and we are big fans of leveraging technology. This allows for automation, reduction of errors, and possibly some time savings.
A few forecasting tools to check out are:
However, at New Economy, we tend to gravitate towards either Excel or Google Sheets. We find they allow us to customize the levers and unit economics and inputs specifically to your business. In other words, we have extreme flexibility when building out the budget.
There is no wrong answer here, but staying consistent with a single tool is the best route.
At New Economy, we build our budgets much like your historical financial statements. So our budgets encompass three financial statements:
- The Balance sheet
- Profit and loss statement
- Statement of cash flows
You’ll need this to produce budget versus actual information but more on that later.
When building out financial statements, we take a detailed approach and use the chart of accounts in your financial statements to build the budget. Yup, we do it line item by line item based on each account so we create variance reporting at month end.
Further, we build out the financial statements by month. So each financial statement will have monthly balances. The end product is a Balance Sheet, Profit and Loss statement, and statement of cash flows that mirrors your financial statement accounts and is produced by month.
Next, we move into the input sheets. These sheets are the drivers, the levers that feed into the financial statements mentioned above. By setting up input sheets, you are able to run “what if” scenarios and change your assumptions which will ripple throughout your financial statements.
Here are some key examples of input sheets:
- Staffing Sheet – This sheet represents the team you have and the new hires you will make. You can add new hires, increase compensation, add benefits, and even remove staff. The idea is to show what your team is going to look like over the next 12 months and how much it is going to cost the business. Again, this is done monthly and at a detailed level.
- Operating expense Sheet – This sheet represents the general expenses and overhead needed to support your business over the next twelve months. Think about expenses like rent, insurance, software costs, and marketing expenses. These are your fixed costs and the idea is to show how much it is going to cost the business. Again, this is done monthly at a detailed level.
- Revenue and Cogs Sheet – This sheet represents your revenue and the direct costs to produce that revenue. We like to get very detailed on the revenue side. For instance, as you build this sheet out, think about the economic units. Meaning, can you build this sheet out showing # of units x price per unit to get to sales? This allows you to make different assumptions around growth. On the Cogs side, it is variable with revenue. We do build them from the bottom up and get a sense of the costs needed to produce one unit of revenue. But we also look at it from the top down and look at the overall gross profit margin as a gut check. Again, this is done monthly at a detailed level.
This is where the magic all comes together.
You should have a good understanding of the financials since the budgeted financials are just a forward looking picture of the actual financials you review at the end of each month.
In our framework section, we discussed the basic layout as follows:
- Balance sheet by month
- Profit and loss sheet by month
- Cash Flow Statement by month
Your traditional financial statements that give you a sense of how your business is performing from a financial perspective on a month to month basis. And we have both the actual historical financial statements for each month as well as the future oriented budgeted financial statements out into the future.
Your Actual and Budgeted Balance sheet will show all of your assets, liabilities and equity.
Your Actual and Budgeted Profit and loss statement will show all of your revenue and expenses.
Your Actual and Budgeted Cash Flow statement will show you where your sources and uses of cash are coming from.
All of the financial statements in our budgets are linked up to the input sheets. So any changes you make in the input sheets ripple through the financial statements automatically.
We feel it is important to take a detailed approach to budgeting and have your budgeted financial statements mirror your historical actual financial statements which we discuss in the next section.
Utilizing Your One-Year Small Business Budget to Obtain Your Treasure
Now that you have a one year budget in place, let’s talk about the ways to use it.
- Variance reporting – Variance reporting is something that happens at month end. Once you close the books for a month and have your actual financial statements we review a variance report. This can be system generated from an accounting system like QBO. The value here is understanding which line items are on track or off track against the budget. Then you can assign a team member to look into why and help understand if any necessary changes are needed to get things back on track.
- What if scenarios – We often get asked questions like “can we afford to hire?” Or “if we do hire, what is the impact on profitability”? While most entrepreneurs have a pretty good gut answer we prefer to utilize the data. We would run the hire and salary through the staffing tab to see the impact on the profit and loss statement. Then we can answer the question accurately as to the financial impact of that decision. So you can use the budget to get a sense of the financial impact of any decision you are about to make in your business.
- Reforecasting – As the months march on we should be learning about the business. We are aiming for the results laid out in the original budget. However, much of the learning we are obtaining may result in some re forecasting. For instance, maybe we want to increase marketing spend above the budget amount because it is resulting in revenues above the budget amount. So you can use the budget to create a reforecast which is simply changing underlying assumptions in the input tabs based on the direction of the business. But be careful, you want to continue to hold yourself accountable to the original budget.
There you have it. We hope the road map above gets you closer to your treasure.
Here are three key takeaways:
- First and foremost, every Company needs a budget. A budget will help you understand the resources needed to chase after your vision. Further, budget will help you to determine on a month to month basis whether or not you are on track.
- Leverage your data to make smart decisions. If you have questions or decisions to make, use your budget to understand the financial implication of those decisions. You now have a tool to help corroborate your “gut” response to decisions.
- Turn your budget into a forecast. Every month, you will be gaining new insights into your business. You have the opportunity to apply that learning along with the financial impact by reforecasting your numbers. We suggest doing this on a monthly or quarterly basis. But keep your original budget intact as those are the goal posts for the year.
New Economy Team Members are Experts in Accounting for Entrepreneurs
If identifying ways to decrease your taxes is not in your skill set or you want to gain control of your finances to make smart decisions to build and grow your business, New Economy is an excellent partner.
We’ll help you get your accounting and taxes done, and done right.
Schedule a time to meet with our Founder, Jeff, and discuss how we can add value to your situation.