As many business owners are painfully aware, it's not an easy thing to create an operating budget for a business whose revenues tend to be all over the map. Yet this is the reality for many businesses.
The need to create and use a realistic budget is increasingly pressing in today's economy, but how do you do that effectively and accurately? Especially if your business revenue fluctuates significantly month to month?
The first step is to determine what's really happening. Is the revenue for your established business really unpredictable? Or is it merely seasonal, cyclical or determined by some other factors that cause it to regularly go up and down? Unless you are a start-up with no revenue history, you will have a record of past performance. This is your foundation for effective budgeting.
A budget is a combination of past trends and future predictions. It is essentially the forecast of future income statements; its emphasis is on profit and the path you intend to take to generate that profit. Sources of sales information and market forecasts will depend on the nature of your business. Gathering this information is essential to creating forecasts with any degree of accuracy. This takes time and work, but it is critical to the development of operational and growth plans that will help your business not only survive, but succeed.
Start with expenses, not revenues
Although this may appear to be counterintuitive, it is essential to have a good grasp on what your costs and expenses are going to be for the period you are budgeting. For most business owners, this is also much easier than predicting revenues. Here are some basic steps to follow:
- Determine your variable costs, or cost of goods sold (COGS). For most businesses this might include materials and supplies, packaging and shipping, etc. In addition, these costs could be commissions and direct customer support costs. It may be helpful to calculate these costs as a percentage of your net revenues.
- Establish your fixed expenses. Be sure that all of your expenses are accounted for, especially any irregular or one-time expenditures that you know are forthcoming. Don't make the mistake of having incomplete data or assigning fixed expenses as variable costs.
- Project your break-even revenues. This important indicator tells you at what point your business breaks even. It is a good idea to know the dollar amount of revenues that exactly covers all of your variable costs and all your fixed costs, with nothing left over for profit. It's also an important indicator of risk because it shows you how close your business is to the "no-profit" line.
Forecast the revenues you expect to see
No one expects you to be a psychic here. On the other hand, you have information, knowledge, experience and insight that are invaluable to the forecasting side of budgeting. Start by pulling together all of your past information. Then consider the nature of your revenue flow - is it seasonal or cyclical? What are the causes of the fluctuations? What additional sources of income might come along in the future? What tangible results of your marketing plans and activities do you expect to see? Once you've pulled the pieces together you can determine the numbers:
- A forecast is a projection modified by what you think will be different. A projection is simply historical information assigned to a future date. It becomes a forecast when you take into consideration any changes or activities you expect to take place, such as implementing a new marketing plan or launching a new product or service. You should also take into account outside factors such as economic trends, downturns, etc.
- Create forecasts for both a conservative and an optimistic scenario. Although you do want to make the most realistic assessment possible for your operating budget, it may be useful to develop contingency budgets for a "worst case" and a "best case" scenario. Strategically planning for lower-than-hoped-for revenues should not be viewed as being cynical or pessimistic, but practical and proactive. And planning for exceptional, or better-than-hope-for revenues, can allow you to generate breakthrough ideas and strategies that can grow your business!
Making it all work for you
Now let's talk about some "nuts and bolts" in setting up and using a budget. Your operating budget is a tool that can tell you whether or not you are on track financially. If you experience unexpected revenue increases or expenses, your budget serves as an "early warning system" to alert you to those changes. The key is to make the commitment to create a budget and then make it as simple and effective as possible.
There are three primary financial statements that should be used in conjunction with your budget: the income statement (profit and loss or P&L), the balance sheet and - especially with significantly variable revenues - the cash-flow statement. Reviewing and monitoring these statements along with a regular, ongoing operating budget is the key to having a strategic grasp of your businesses financial health, performance and progress.
According to Wendy Alexander, director for small business for Capital One Financial, the biggest mistake for business owners is to treat a budget as a one-time exercise, or a once-a-year process, rather than seeing it as a living document to be used to run the business day to day. And the most common mistake is that entrepreneurs usually need some help with their budgets, but they don't ask for it. Having a CPA or other financial advisor help you prepare a realistic and effective operating budget is a great idea.
The bottom line is that regardless of the nature of your businesses revenue, creating and using a budget is not only something that you can do, it is something that you need to do.
Share your story
Are you challenged with inconsistent revenues? Have you put any of the budget strategies we suggest into action in your own business? Post a comment and tell us about it.
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