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Proper financial management is essential for the success of any business endeavour. Most businesses, particularly small businesses, that do not make it past their first or second year of operation, fail because they have not taken the necessary steps to plan and manage their finances. One of the first and most important steps in financial management is planning a budget for your business.

Budgeting should be done on a regular basis, but most especially at every important turning point that your business faces, for example, when considering investing in new equipment, taking on a new lease, or considering expansion. Taking the time to properly prepare your budget regularly will help you to determine the capital that you have available, whether or not you have funds enough to achieve your business goals, and if not what steps can and should be taken, helping you to gain and maintain control of your business.

— What is a Budget?
A budget is a forecast of all of your business’s income and expenditure, including all income streams and payable accounts for a specific period, often done monthly, quarterly or annually. Creating an annual budget is generally the most effective way to plan for the coming financial year, however, annual budgets can then be divided into monthly budgets and reviewed on a quarterly basis, to keep track of income and expenditure.

At the end of the allotted period, the budget forecast is compared to the actual accounts records. A well planned annual budget should be roughly in accordance with the business’s actual performance, as recorded in their financial statement, and will help you to plan profits, spending and overall cash flow for the following year.
Creating a budget for your business will not only help you to plan for the future, it will also help you to monitor your business’s performance, to quickly identify areas where you may be overspending, and to see where your business is losing money. Once your budget has been created, reviewing it regularly by going through an estimated vs. actual profit and loss statement can help you to spot these problem areas and to avoid possible financial pitfalls in the future.

If you are setting up a new business, it is a good idea to include a budget as part of your business plan, particularly if you are applying for a loan from a financial institution or approaching possible investors. A well planned and realistic budget will help investors to see how your business is likely to perform, and how long it will take for them to see a return on their investment.

— The Budget Equation
The basic budget equation states that:
Income – Expenditure = Profit

To determine an initial amount for your budget, there are three main areas to consider; your business’s sales income, including all possible income streams, the total business expenditure for the budgeted period, and your estimated profits.

When collating income figures for the period that your budget will be covering, make sure that you consider all of your business’s income streams. While sales figures will most often make up the bulk of your income, you should also take into account things like interest, dividends, royalties etc. that your business may be receiving. Any form of regularly received income will count toward your business’s overall income. Estimate your income based on previous figures whenever possible, while also taking into account the current economic climate and recent sales trends. Try to make your estimates as accurate as possible, to increase the efficacy of your budget.
Once you have estimated your business’s income for your budgeted period, you can calculate the necessary expenses required to achieve your goals, and see if you can afford to pursue them now, or how long it will be before you can.

Your business’s overall expenditure for your budgeted period will include all fixed and variable costs, and may also need to take into account inflation and other adjustments, depending on the length of time your budgeted period covers.

Fixed Costs
Your business’s fixed costs are payable amounts that will not change by any significant amount throughout the time allotted by your budget, regardless of how your business is performing. Costs such as rent for office space and equipment are fixed for a specified period by the terms of the rental agreement and cannot vary within the period that the agreement covers. These can be estimated accurately based on such agreements.

Variable Costs
Costs that will change significantly within your budgeted period are your variable costs. It is more difficult to estimate variable costs, as they can change based on a number of factors. Some examples of variable costs are your business’s product stock, which can vary greatly depending on your sales and on market prices for materials, transport costs, which will also vary based on your sales, and utility bills. A realistic estimation of these costs should be based on previous payable accounts and predicted sales.

If your budget is covering a period of one or more years, you will need to take into account the rate of inflation when estimating your variable costs. The price of goods and services, such as stock and transport, can increase based on annual inflation rates, so it is important to consider these rates when budgeting, in order to estimate your costs as accurately as possible.

Ideally, your business’s profits should be high enough to make a return on investments, as well providing you with a fair return on your labour. Achieving a return on capital invested in your business by parties other than yourself should be your first priority, in order to satisfy your investors. Personal investments, including the amount of money that you put into your business as start up capital, and the profit from previous years that you have reinvested into your business, should be your second consideration. It is also important that you receive a return on the time and effort that you have put into the business; the amount that you pay yourself on a weekly, fortnightly or monthly basis should reflect when you could earn working for someone else.

Using these concepts and the basic budget equation, you can estimate your budget for a specified period and plan how to manage your business’s finances, allocating funds appropriately and estimating profit, in order to determine whether or not your business goals for the future are achievable. When setting your budget, remember that it is always safer to over-estimate costs and underestimate your sales income, to decrease your risk of going over your specified budget.

— Constructing your budget
For practical purposes, most small businesses will forecast their profits for a specified period when creating their budget. Once you have determined the profit amount you can calculate the expenses that will be incurred in order to make the profit amount and the income that will need to be generated in order to cover the amount of expenditure. To construct your budget step by step, you will need to:

1 – Target desired profit: Estimate the amount that your business needs to make in order to provide a return on financial and labour investments.
2 – Determine operating expenses: Calculate the expenditure required to provide your desired profit, taking into account fixed and variable costs, as well as inflation rates.
3 – Calculate gross profit margin: The gross profit margin will be the sum of your net profit and your total operating expenses.
4 – Estimate total income: Determine the amount of total income required to achieve your gross profit margin, taking into account the amount the cost to your business of the goods sold to reach your target amount.
5 – Adjust figures: If your calculated figure for your business’s total income is realistic and achievable, your budget is complete. However, if this amount seems problematic, your desired profit margins and operating expenses will need to be adjusted accordingly.

When creating your budget, it is important to construct a well planned and comprehensive document. Be sure to make your estimates based on past performance, the current economic climate, and realistic figures. You should also consult financial professionals, such as your bank or accountant, to add detail and accuracy to your estimations. It can take time and effort to plan your budget properly, but in the end you will have a document that will be more effective in helping you to manage your business’s finances, and to plan for the future.

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