Why Bother with Budgets?
Does anyone really get excited about doing a budget? Doing a budget takes time. Doing a budget takes effort. Doing a budget sets limits and boundaries. You are already busy. Life, work doesn’t wait for you to do a budget. Transactions do not stop occurring so that you can sit down and do a budget. Do you really need one more task? As long as you’re conservative with your money, you don’t need a budget, right? Well, the truth about budgets is that it may not be about what you’re missing by setting aside time to do a budget, but what you are missing by NOT taking the time to do a budget.
Let’s consider a real-life scenario. You love to shop at Target (or fill in your own “can’t say no because they have so many neat things” place to shop.) You can drop $100 at this store like nobody’s business. You can bet that every time you set foot in that store, you will spend $100. Well, what if a wealthier friend gave you access to his checkbook and set you free to shop at your favorite store without any spending restrictions? Would you only spend $100? Probably not.
Herein lies the problem. You can’t operate out of someone else’s checkbook. You have to work with what you have. This simple scenario shows you the need to have a personal budget. But what about your business? The same concept applies: You have to work with what you have.
To work with what you have, you have to KNOW what you have. Remember when I said you might be missing out on something by NOT doing a budget? In a business, the goal of a budget is to determine what your costs are so that you can determine your revenue. Your business budget helps you find your break even point and then allows you to set some goals with revenue. The rest of this article will focus on the specifics of determining the costs for your business and putting these items into your budget.
The first step to building a budget for your business is to set up some budget categories. But before we get into specific line items, let’s consider some major budget areas. There are three main expense areas in any expense budget:
- Fixed expenses
- Variable expenses
- Discretionary/investment expenses
Fixed expenses are the ones that you are pretty much stuck with every month. The amounts of these items often do not vary greatly from month to month, but you can count on them to be there every month. Examples of fixed expenses might include:
- Insurance (property, umbrella)
- Depreciation estimate
- Property taxes
- Salaried employees
- Building maintenance
- Office expenses
Variable expenses change depending upon the volume of business you are conducting. Higher amounts of sales or payroll create more expenses. For example, a large subcontracted job may not change variable expenses by as much as a large self-performed project. Keeping your expected workload in mind as you consider your variable expenses can create more accuracy. Some of these categories may be easier to build by calculating them as a percentage of revenue or wages. These variable staffing expenses may include costs of labor like:
- Commissions and bonuses
- Workers compensation and general liability insurance
- Payroll taxes
- Safety & security
- Tools and consumables
- Cell phones
- Health insurance and other benefits
Discretionary Expenses and Capital Assets
Discretionary expenses are items that you don’t have to spend money on, but maybe you should to reach your goals. These could be things like public relations, advertising and extra training for your staff.
Discretionary expenses may be contingency items. For example, if the business performs well, you can create a bonus pool. This pool could be used for bonuses in the typical sense or for other perks to reward your employees for a job well done. Examples of this may be parties, gifts, or fancy coffee in the coffee maker.
Larger expenditures that don’t fall into the category of fixed assets may also be discretionary expenses. The best example that we see is technology investment. Maybe you would like to buy 5 new laptops this year. Most laptops are under the $2,500 IRS limit and would show up on the income statement as an expense. These discretionary items should be a contingency item in your budget.
Items that are over the $2,500 limit would not go in this category on the income statement as they are fixed assets and belong on the balance sheet. However, these types of items naturally are discussed as part of the budgeting process. Instead of putting these items in your expense budget on the income statement, you would need to break out these items on a separate list of capital expenditure goals.
Some examples of items that would go on this list would be:
- Tools over $2,500
(The topic of capital assets will be covered in a future post)
Once you have built the budget, we recommend that it is input into your accounting software. Most accounting software has a budgeting tool of some kind. Once your budget has been put into the software, reports can be run to help you and your team manage your budget on a monthly basis. Most software will allow you to run your monthly financials to compare budgeted vs. actual expenses which makes quick work of determining whether you are on track.
Now that you have your expense budget, you can calculate your breakeven sales point. In the simplest form, the breakeven sales is how much it is going to take in revenue to get net income to zero. This calculation includes an average gross margin as well. We will cover a breakeven calculation in another blog post.
For me the best part of the budget is feeling like I’m in control. I know there will be unexpected costs and savings throughout the year. However, once I create a budget and stick to it, I gain a whole lot like peace of mind, an accurate picture of the business, and insight into strategic revenue opportunities.
Get started. There’s no time like the present!