You should develop a budget for your next fiscal year a quarter before the end of the current year. A budget exists to help guide you in your business versus constrain you, as many business owners feel. An actual budget looks at your income statement and balance sheet and enables you to do proper cash-flow planning.
Income Statement
The income statement is a view into your revenue, cost of goods, and expenses for your business. Also called a profit and loss statement, the income statement provides a view into the business's profitability over some time.
Revenue Forecast
Looking at the last three to five years of financials gives you a view of your business growth. If you have been in business for at least three years, you should have a revenue, cost of goods, and expense run rate. For example, suppose you are adding a new product or service. In that case, you will want to account for that revenue in addition to your expected growth. Other items affecting your revenue could include a new sales channel or an increase in pricing, to name a few. A forecasting exercise should look at prior years, seasonality, and your strategic plan for the following year.
Cost of Goods Sold
The Cost of Goods Sold is the product costs that change based on the volume of revenue you sell. The Cost of Goods Sold will differ by business. For many product businesses, your cost of goods sold will likely include differences in inventory, labour, and inbound shipping. For example, a manufacturing business may allocate a portion of utilities or other variable items that change based on production. For a service business, you may have contractor costs, for example.
An Increase in supplier costs, direct labour costs, or even inbound shipping can affect your margin.
Margin is (Revenue - Cost of Goods Sold)
It is vital to plan for potential cost increases and decreases in your budget.
Expenses
To budget appropriately for your expenses, you will need to understand the changes that will occur within your monthly and annual expenses in the next year. Changes in costs will affect your bottom line. For example, with changes in the minimum wage, your payroll expenses are going to increase. Once you have completed your marketing budget, this should be input into the expense line as well, along with any other changes, such as increases in rent, utilities, bank fees or insurance, to name a few. You will need to account for any new headcount or expenses that you will incur next year that are up and above the current year in addition to increases and decreases.
Balance Sheet Items
To develop a budget, you must look at your balance sheet and income statement. The balance sheet is a financial statement that outlines your business assets and liabilities at a specific time point. Current assets on your balance sheet include the cash you have on hand, inventory, accounts receivable, and prepaid, to name a few. Long-term assets include, for example, equipment, land and buildings, and furniture and fixtures. Current liabilities are accounts payable, taxes, current year portion of a loan. In contrast, long-term liabilities include long-term loans, capital leases, customer deposits and deferred taxes.
Outlined below are a few items on your balance sheet that you need to plan and budget for each year, as they will affect your monthly cash flow.
Inventory - ensure you account for the stock you plan to carry on your books, as this can affect your cash flow.
Capital Expenditures - if you plan to purchase any capital items, you need to account for them within your budget. (Equipment, renovations, furniture)
Loans - if you have loans you are paying off or plan to take on next year, they need to be accounted for within your budget.
Cash Flow Planning
Once you have determined your income statement and balance sheet forecast, you can determine your cash flow. You will take the income generated from the business and factor the changes in your balance sheet in 3 areas: Cash-flow from operating activities, Cash-flow from investing activities, and Cash-flow from financing activities. A budget helps you in planning your cash flow for the next year.
If you want to make $50K at the end of next year, you will need to adjust the funds used to pay off or add to the debt, buy inventory, or buy equipment.
Summary
Budgeting is critical in helping manage and execute your business plan and finances on an annual basis. Budgets are not stagnate. They need to be updated monthly as your results from the prior month are closed. You may have to adjust your budget accordingly throughout the year for other months based on the markets, economy, or other factors. If you need help developing a budget for your business or know where to start, we can help you do this. You can accomplish this through business coaching, where you will acquire the skills to do this on your own, or through a financial management engagement, where we will do this for you with your input.