Budgeting From The Ground Up: This Budget Actually Means Something

Most small business seem to have a strong dislike for budgeting.  The feeling is that budgets are just a time wasting distraction from the things that really need to get done. You probably have similar feelings toward budgeting.  And you’re right.

Budget

Budgeting is a waste of time if you do it the way most small business owners do it.  You know the way – where you do a “mathematical” budget by increasing revenues and expenses and come up with a “magical” net earnings figure that you don’t really believe, or even know how to actually achieve.

But the truth is that you CAN create a budget that is useful for you.  One that actually helps you create the financial results you want and helps you identify what actions you need to take in order to keep driving toward your targeted financial results.

What is the path to an effective budget?  Here are seven quick steps.  Follow along and it won’t even feel like you’re creating a budget:

Step One

The first step is to create your revenue budget.  The way to do this in a meaningful way is to start with the number of customers you have historically served in your budget period.  For example, if you serve 75 customers in a month, this would form the starting point if you were budgeting for an upcoming month.

Step Two

Determine your average transaction size in the past for the period you are trying to budget for.  For example, if your average transaction size has been $250 in similar recent periods.

Step Three

Based on your historical number of customers for the period and average transaction size and given your planned marketing and sales efforts, decide what you feel is an appropriate target for number of customers and average transaction size.  For example, if you have an upcoming marketing campaign scheduled that will generate a number of new leads compared to the number you would normally expect you should adjust your target number of customers upward to reflect this.

Step Four

Multiply your target number of customers, and average transaction size together.

You have just created a revenue budget for your business by actually looking at the elements that create revenue.  Even more important, you have created granular targets (number of customers and transaction size) that will guide you every day in your budget period to knowing if you are on track to create that revenue or not.  If not, where you are falling behind.  For example, not enough customers, average transaction size smaller than planned, etc.

Step Five

Use the targets you just set for the number of customers and average transaction size and your anticipated direct costs to determine your budgeted direct costs.   For example, if you are expecting an increase of $2 per additional transaction, make sure you account for this in your budgeted direct costs.

Based on the budgeted revenue and direct costs you have now created, you have determined your budgeted gross profit (revenue minus direct costs) which you will have available to cover your budgeted overhead.

Step Six

Examine your historical overhead costs for the budget period.  For each major overhead item, adjust it up or down as appropriate based on actual changes you know are coming, or that you anticipate.

You have now created your budget for overhead expenses.

Step Seven

Subtract your budgeted overhead from the gross profit budget you created in step five and there you have it.

You have just created a useful, relevant budget in seven quick steps.

How Do You Use It To Create The Financial Result You Want?

So now that you’ve created your budget from the ground up, it’s time to use it – daily.

The biggest element of driving toward achieving your budgeted financial results is to ensure you meet your budgeted revenue targets.  This requires you to monitor the actual number of customers you have served and the actual average transaction size you have generated.  Then you need to compare both these amounts to your target number of customers and average transaction size.

By monitoring and comparing in this way, you will know daily, weekly, monthly – as often as you care to look – how closely on track you are toward creating your target financial results.

Then you can take quick (almost instantaneous) action to bring your actual results back on track to match your targets.

Budget Photo via Shutterstock

3 Comments ▼
Advertise Here

Steve Wilkinghoff


Steve Wilkinghoff Steve is a leading small business expert and author of the book, Found Money: Simple Strategies to Uncover the Hidden Profit and Cash Flow in Your Business. His experience with thousands of small business owners around the world has allowed him to create a proven set of tools, processes and an online software app that allow small business owners to create the financial results they truly want. You can find out more at Found Money CFO.

3 Reactions

  1. Steve–this is good information. We used to take the budgeting one step further and also work backwards from expenses. Generally, you had a good idea of what your expenses were going to be in the upcoming month(s). You knew what payroll, rent, vendor costs, etc. were going to be, so there were rarely any large one-off surprises that you didn’t expect. With that information, you could figure out the revenues you needed to achieve a certain profitability. Then, you could work backwards from the revenues to determine number of leads, activities to get the leads, etc. to meet your revenue targets that would give you an appropriate profit margin.

    You do a great job of pointing out that budgeting isn’t that hard. It’s not rocket science, but it’s also crucial, as it sets a minimum bar for the activities you need to perform to keep growing as a company. People run and hide, turning into a quivering pile of fear when they’re faced with the concept of budgeting, but they, as you rightly point out, shouldn’t do so!

  2. It is true that many small business owners think that budgeting is a waist of time just because they aren’t doing it the right (and therefore useful way). It is mainly a matter of knowledge and I think that you have given a good quick tour on the process.
    Another challenge that small companies have to face is how to record the monthly transactions accurately to monitor their projections.

Leave a Reply

Your email address will not be published. Required fields are marked *

*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>



Compare your business to the industry - Try our new tool