Understanding How to Use a Business
Budget and Manage Money Effectively

Money is the lifeblood of your small business. When you’re taking in enough revenue, have costs under control and are working with healthy profit margins, your business will grow. Business failure isn’t generally due to lack of money; four times out of five, the issue is poorly-managed budgets and cash flow.

One of the best ways to avoid cash flow problems and increase business growth is by creating, tracking and sticking to a business budget. We’ll explore what a business budget is, why it’s important and how to put one in place.

This guide will help you get your business budget into great shape to enhance the financial management of your company.

Why Cash Flow and Business Budgets Matter

Cash flow is simply the movement of money through your business. The reason it’s such a problem for so many businesses is timing. When you have money tied up in stock or you’re waiting for an invoice to clear, unexpected expenses can cause all sorts of problems.

Green Gizmo Ltd had $10,000 in the bank. They spent $8,000 on stock and have sold over $12,000 worth of goods with their markup. Unfortunately, this a big order from one customer, and the invoice will take 60 days to be paid. In the meantime, a rent payment reduced their balance to just $500. Now they have almost no money for utility bills, salary payments or unexpected expenses. That's bad news.

Budgeting resolves the cash flow problem because you know how much you expect to receive from customers and how much you will need to pay out to suppliers and others. That lets you keep enough cash in your business to act as a cushion against the unexpected, and it means you can invest sensibly to grow revenue and profit.

The Five Vital Parts of a Good Business Budget

There are five areas you need to get right if you want to grow your finances properly:

Creating a realistic budget

Tracking and reconciling what you’re taking in and spending

Measuring, analyzing and updating your budget

Building a buffer

Forecasting for the future

Let’s Dig Into These Areas…

Creating a Realistic Budget

There are three things that make up a business budget:

  • The amount of revenue coming in
  • The amount of expenses going out
  • The difference between the two, which is money staying in the business

It’s time to pull out your bank statements and look through them to identify income and expenses.

Reading an Income Statement

You can only create a budget if you have money to spend. Calculate your revenue as follows:

  • Look at how much money you’re bringing in over time
  • Work out your income on a daily, weekly, monthly, quarterly and annual basis
  • Understand individual revenue streams
  • Note your total revenue amount
  • Take account of seasonal trends
  • Consider lag time between selling goods and services and receiving payments

It’s time to pull out your bank statements and look through them to identify income and expenses.

Understand What Expenses You Are Paying Out

Expenses are any costs incurred by your business. These include:

  • Costs of providing goods and services
  • Operational costs, salaries, employee benefits, utilities, office rental, distribution, etc.
  • Taxes, customer service and hidden costs

You should combine this knowledge with an understanding of your profit margin. Go through your business bank statements in detail to learn exactly where you’re spending money to take everything into account.

Work Out How Much Money You’re Retaining

Once you’ve added up all your income, take away your total expenses, and hopefully you will be left with a positive number. (If it’s not a positive number, you will need to increase revenue or reduce costs, and fast!) Any money left over you will keep in your business, and you can put it toward a cash buffer and growing your business.

Your business, Blue Widget Co. takes in $20,000 a month on average and spends $14,000 a month on goods, salaries, operational and hidden costs. You’re creating profits of $6,000 a month, which you can use to grow your business or create financial stability.

It’s useful to drill down into your revenues and costs. Categorize all your income and expenses into different “buckets” so you can see the main contributors to your profitability.

Tracking and Reconciling Your Budget

Once you know what you’re taking in and spending, you can predict what your likely future income and expenses are going to be. Here’s how:

  • Create realistic spending and revenue goals across all the areas of your business
  • Track how well you’re meeting those goals over time
  • Record all of your sales, invoices, expenses and bills

It’s easiest to do this in an online accounting program that’s built for financial management.

One other task you will need to complete regularly is reconciling your bank account against your budget. This means going through all your business account transactions and matching them to revenue and expenses in your business. This helps you stay on top of your budget and makes accounting and tax preparation much easier.

Measuring, Analyzing and Updating Your Budget

Business budgets are never static. Marketing increases sales, the cost of raw materials changes and you may give your staff a pay raise. That’s why you need to regularly review your budget calculations, preferably on a monthly basis. Track how well your actual income and expenses match your predictions and tweak things as necessary. Measuring, analyzing and changing your budget is vital to staying flexible and growing your revenue.

You had a really good year, so you’ve been able to offer healthcare as an employee benefit. Make sure that going forward you factor the costs of healthcare premiums into your salary and benefits costs.

Building a Buffer

Remember how Green Gizmo wasn’t able to meet all their expenses? That’s because they didn’t have enough of a cash buffer. Keeping money in your business gives you the financial stability to weather surprise storms like downturns in sales, unexpected expenses and other risks. We strongly recommend building up a healthy buffer of cash in your business. It reduces worry and enhances your business strength, because not everything will be “down to the wire.” We recommend keeping between three and six months of operational expenses.

It costs you $14,000 a month to run Blue Widget Co., so you would want a cash buffer of $42,000 to $70,000.

Forecasting for the Future

The real power of the business budget is that it doesn’t just tell you how well you’re doing now; it can help predict how well you will do in future. When you have costs under control, stable revenue and a cash buffer, you can look a little further out to make future forecasts and investments. When you know your budget numbers and can account for future changes, you can make predictions and build business models that help you decide where to invest next. That’s the real secret to growing revenue. There you have it: our no-nonsense guide to creating, tracking and using an effective business budget.

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