Setting up a Budget for a Small Business

by Victor G. Butcher, CPA, LUTCF

Prior to becoming a certified public accountant and moving to Tennessee, my wife and I started a retail business in Plano, Texas. Our business was selling educational toys from around the world. Before we even approached various banks and lending institutions to see who had the best lending rate, I had to develop a budget based on a reasonably conservative estimate of our income and expenses for the next three to five years.

Budgets are a financial expression of an organization's plans for a particular period of time (generally a year). Budgets tell where and how the organization will spend money and where the money will come from to pay these expenses. Some typical questions that a budget will answer for an owner or manager of a business are: "How many personal computers can I afford to purchase?," "How many people can I hire and at what rate of pay?" and "How much revenue must my company produce and from what sources will this money originate?"

Budgets also set limits. Imagine how chaotic an organization would be if everyone was allowed to spend as much as they wished on whatever they wanted. Companies that have followed this approach often find themselves bankrupt because their income could not offset their expenses. Besides setting limits, budgets can help assure that the most important needs of an organization are met first and less important needs are deferred until there are sufficient funds in which to pay for them.

There are three functions that a budget should perform: planning, evaluating and controlling.

Planning - What do we intend to do?

It is important to know that budgets do not function well when treated as an isolated business procedure. To get the full benefit of budgets and budgeting, ownership or management must link the budgetary process to the other key business processes such as sales and marketing, public relations and advertising and yes, even accounting.

It is a good idea to spreadsheet all known revenue producing areas as well as know and understand all of the expense categories. In this way, management and owners can start getting a grasp of their "peak" business periods as well as their "off" business periods. The company begins to get an understanding when they need to "staff up" or just hire temporary employees to help them with their budgeted increased business. This philosophy is the same whether a new business is in wholesale, retail or the service sector.

Lending institutions are very attentive to the budgets that borrowers bring in to their loan committees. One of the first rules, which really is a common sense approach, is make your initial budget reachable. Obviously, we would like to show as much profit (on paper) as possible to a lending institution by increasing revenues and decreasing expenses unrealistically. Banks see hundreds of these budgets a year. As the saying goes, "If it looks too good to be true, it probably is not true."

Be conservative with your approach

Most companies lose money in their first year of operation. If chances are good that your company will lose money immediately, then show it on your budget. Lending institutions want to deal with practical business people, not dreamers or people who do not have a clue how to run a business. Unless you have a lot of expendable savings when you start out in business to tide you over at the beginning of your new career, be very realistic with your budgetary approach. I still remember a quote from a fellow retailer in Texas when we started our toy business, "If you want to wind up with a small fortune starting your own business, then start with a large fortune."

Evaluating - How are we actually doing?

Some organizations take budgeting so lightly until the year is nearly over that they suddenly realize that they have to put on a "hiring freeze," until the financial people can figure out if they can pay the incoming bills. If the financial situation gets too bad, then the organization starts to make painful, but very predictable, across-the-board cost cutting measures.

Controlling - What do we need to do to get back on track?

A budgetary process should be ongoing. If business is better than you first expected, revise your numbers to show the increased income and start planning on your most important capital expenditures. However, if business is not as good as you first planned, even using the most conservative approach, see where you can cut back in the least painful ways. Adjust your budget numbers and compare them, at least monthly, with your actual numbers. Remember, you are an owner or major stockholder of a new business now. If you never took a management class before, you are now forced to have on-the-job training. Make the hard decisions as quickly as possible. If you allow an area to fester, it could eventually bring down your entire organization.

If you have absolutely no accounting experience, work with a CPA to develop your original budget. Many CPAs have experience in various lines of business. They can help you identify your peak and valley periods as well as warn you of the type of expenses to expect. Also, a certified public accountant can help you evaluate how your business is actually doing.

When working on a budget, I prefer using an electronic spreadsheet, such as Lotus or Excel, because numbers and formulas can be changed with very little effort as new information comes in. It also presents a budget in a readable form that lending institutions have both seen before and understand.

Conclusion

Budgeting does not have to be a financial form of fortune-telling. Use a conservative approach when coming up with your sales and expenses. Make sure your budget tells what you intend to do with your business. Constantly evaluate your actual numbers verses your budgeted numbers (at least monthly) to see how you are actually doing. Lastly, plan on what you can do as the owner or management of your new business to get back on track. Do not view budgeting as a necessary evil. Consider the budgeting process as a management tool to help keep your company profitable and keep your company running as smoothly as possible.

About the Author

Victor G. Butcher, CPA, LUTCF, is an individual practitioner in Cordova, Tenn. Butcheris a member of the Tennessee Society of Certified Public Accountants, the state professional organization for more than 8,000 CPAs in government, education, industry, business and public practice and its Memphis Chapter. TSCPA's Memphis Chapter is one of eight chapters across the state with more than 1,500 members in three counties. For more information on small business issues, visit the Tennessee Society of CPAs' Small Business Resource Center on the Web at www.tscpa.com.