For a business to have an understanding of where the business is going and what it’s trying to achieve, it should have a budget plan. A budget is a financial plan for your business that covers a specific period of time, detailing what you expect your business to achieve.
A budget can also help to reduce any uncertainty you may have, reducing risk and identifying any issues that might arise in the future.
Read further to learn what a budget is, the benefits it can provide and how to prepare a sales expenditure budget. Also how to use it to keep control of your business finances.
Why have a budget?
Having a budget allows a business to set out what they expect to spend and where the money for that expenditure will come from. Secondly, a budget is there to be referred back to whenever to evaluate whether the business is achieving what was expected.
What can a budget provide?
A financial budget can provide purposes such as:
- A framework that can manage a business’s finances effectively.
- insight into how a business can calculate funding needed.
- Financial figures against the actual performance.
- A detailed financial plan from which business decisions can be made from.
How do you prepare a budget?
It is standard practice to prepare a budget to cover 12 months’ time. This may not be in correspondence with the calendar year.
For an established business it comes easier to prepare a budget as there is a trading history already there to base the budget on. Whereas for a start-up business there is no previous trading history.
A start-up will need to make assumptions about how the business will perform and be able to justify the budget figures against the assumptions made.
A business plan is a need to prepare a budget. Preparing a budget with the business plan can help to identify any areas in the business plan that might need altering.
The budget plan of a business will quantify, in financial terms, the expected sales income received and expenditure that will be incurred by the business.
The main budget areas are:
Sales income.
Expenditure:
- Capital costs, an example of this, is equipment.
- Variable costs or production costs such as raw material bought for processing of goods bought for resale. Which will vary in relation to sales.
- Fixed or overhead costs in relation to running a business, for example, rent, rates etc.
Preparing for sales
Start-up businesses will find this particularly hard to do as there is no previous sales history to base expectations on.
Rather, the budget should rely on solid research and be tied closely to a realistic marketing plan that will generate the sales you expect.
Read developing a marketing plan and forecasting sales: making it make sense; for more information.
Guessing sales will not work out for a business’s benefit.
The sales budget can be split into different products/services that a business plans to sell.
Any business should consider the following issues when developing a budget for each product/service.
- Number of units they plan to sell.
- The price of the product/service.
- The different customer groups that a business plans to target.
After considering all of the above, a business will have a clear idea of what is being sold, who it is being sold to, and how much it is being sold for.
Remember, be cautious and realistic!
Get the ulimate guide to start a business
Budgeting for expenditure
Having prepared a sales budget a business has a basic foundation for what expenditure will be.
Overall, there are three main types of expenditure for which a business needs to budget; variable, fixed and capital expenditure costs.
Variable costs
After a business knows the sales that’ll be produced it can then calculate the variable costs. Which will change in line with the sales. Variable costs to considered:
- Materials and components needed to produce the product sold.
- Payments to affiliates: staff and sales agents who earn a commission with their fixed salaries.
Understanding the costs that occur for each product/service sold is vital to preparing an accurate budget. A business should prepare a budget for the cost of producing each product/service.
Then a business can review the costs associated with each product to ensure that its proposed selling price generates an acceptable gross profit (the selling price less the variable costs). This helps to identify which products/services are most profitable.
Fixed costs
Next are the fixed costs (can be known as ‘overhead’ costs), these can stay more or less constant, irrespective of changes in sales or whether any sales are made at all.
These can be:
- Rent and business rates.
- Salaries including National Insurance and pension contributions.
- Wifi/ telephone and utilities charges.
- Insurance: building, contents, or public liability insurance.
- Fees for accountancy and legal advice.
- Finance costs- bank charges, loan interests, leases, hire purchases, etc.
- Marketing, travel, and promotional costs.
For a business in the manufacturing sector, fixed costs will be a relatively small proportion of the total costs. Indifference, if a business is in the service sector, fixed costs can represent a high proportion of the costs of running a business.
Reducing these costs can be hard. This can become a problem if a business does not achieve its expected levels of sales income, so aim to keep costs to a minimum so a business can operate profitably and effectively.
Capital expenditure
Capital equipment will be needed such as machinery to use in the business.
So, a business will need to determine what they can afford in the budget that’s available and whether finance is needed.
Alongside, deciding how a business will pay for equipment, is that in cash or loan?
Sometimes finding a loan or extra cash can be quite hard for a start-up, however, here at EMS we offer a brand new funding scheme called The Funding Hub! – Visit the page to learn more and see how YOU can get involved!
When a business finally knows all these different answers they can then decide when they will buy it and how long they will be paying it off.
Budgeting using a cash flow
When operating a business on a cash basis, using cash for purchases, and taking in cash for sales, it can be easy to monitor the cash flowing in and out of the business.
A business should see cash left over at the end of the month if it’s making a profit. A few business owners such as those in the retail sector operate entirely on this basis. It is common that a business could be selling goods or services but not receive payment till a month later.
With knowing this information, a cash flow budget will use information from the income and expenditure budgets, but also take account of when a business is expected to get paid by customers and when expected to pay suppliers.
A cash flow budget will help to identify the amount of cash that is needed to set up and run a business during the first year and whether an owner can fund it primarily themselves or if help is needed.
Putting the budget to work
A budget can be used as a control mechanism and, at the end of the month, compare the actual figures for sales and expenses with the figures that were budgeted.
When a business evaluates these figures and notices a big difference it’s crucial to look back and understand what made the difference.
For example:
If sales are too low, a business needs to rethink its pricing strategy or determine whether one of its products is underperforming against the target.
In contrast to this, if sales are high, changing the cash flow forecast to match this is required as working capital requirements might increase.
Finally, if the certain expenditure is way high a business may need to reduce costs- possibly mean finding a new supplier.
A budget is like a business plan, an active document that a business should refer to. When a business notices its original ideas aren’t working in practice then change is needed. A business should be prepared to review and revise every three months in its first year.
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