business finances, revenue, Envelope accounting

Creating A Brilliant Business Budget

Smart budgeting is one the most vital indicators of a successful business plan. You most likely did not get into business because you love accounting (except maybe my CPA friends). With or without a love of accounting, a budget holds power. No business size, market, or industry can escape bad budgeting. I am recently rereading Profit First by Mike Michalowicz. Do yourself a favor and read it if you haven’t yet. It will change your business financials for ever.

Know your real revenue and don’t forget the overhead

Real revenue is total sales price – the cost of goods and services directly related to that sale. If you sold a widget for $10 and the raw material cost of the widget is $4, your real revenue on the widget is $6. Michalowicz suggests basing your budget around your real revenue numbers. Real revenue does not take into account overhead expenses for things like rent, utilities, marketing, etc. This is important because you can’t host a sale to sell your widgets for $4.25 and hope to make a profit. If you price your product below your real revenue + overhead, the business will end up in the red.

It is all about the %

A billion dollar business can outspend their sales just like solopreneurs and startups can. Budgeting is not all about sales. Budgeting is more about % than it is about dollar amounts. In Profit First, Michalowicz talks a lot about determining how much of your sales should be allocated to operating expenses, saved for taxes, saved for large purchases, given as owner salary, and saved as profit. He has a unique perspective that you plan for profit as part of your budget and not leave it to chance, brilliant.

As your business grows, the % allocations to each area of your business will also shift. Michalowicz suggests that businesses under $250K reserve 50% of real revenue for owner compensation. Businesses between $250K-$500K should reserve 35% of their real revenue for owner compensation. That doesn’t mean that the owner makes less as the business grows, it is just distributed differently to account for increased operating expenses and increased owner draws. It is also important to note that some costs grow at the same pace as sales while others do not. If a widget company doubles in sales, the cost of raw widget materials may double but the office internet service will not.

Set Rules

Just like your personal finances, business finances also require a lot of discipline, maybe more. It is tempting to use business funds because we are lured into a “write off” or because our business account feels like a buffer for our personal account. Setting clear rules will prevent you from slipping on your business budget.

Here are a few rules that we live by in my business.

Distributions run on a schedule not on desires

It can be tempting to take an owner draw from my growing profit account when I have my eye on a fun vacation or new sofa. To prevent overdrawing my profit, I only create owner draws quarterly and only take 50% of that profit account. That leaves me rewarded for my hard work and never cash strapped in business.

Save for taxes

I know my tax bracket for business. If you are not sure what your tax bracket is, ask your accountant. I save my tax % on each sale and never touch it until I file taxes the following year. Preparing taxes is stressful enough without having to worry where you will get the money to pay the taxes. If we have more money left over in the tax account after paying taxes, I take it as a distribution.

Envelope accounting

Have you ever tried the envelope accounting system for your personal finances? The idea is that you divide your cash into several envelopes that represent categories of spending such as groceries and gas. We do the same thing in business but instead of using envelopes, we use different checking accounts. The rule is that we can not borrow from one account for another. For example, we can not increase our operating expenses and draw the overage from our tax account. We do have a savings account that can be drawn from for larger expenses but never ongoing costs.

Embrace and Own Frugality

I have a female friend that is over 6 feet tall. She knows that the first thought others have when they first meet her is “How tall are you?”. Instead of watching them half listen to her as they try to calculate her height, she starts out with “I am Stacy and I know you are wondering how tall I am. I am 6’2’’”. I love this approach because it address it instantly.

I work from home and I love the cost savings it gives me. I am able to pass the savings on to my customers as well. A few years ago, I was embarrassed to admit to working from home. I felt that it reduced my credibility but that just isn’t so. When clients ask if we can meet in my office, I am happy to tell them how I work from home and suggest a different meeting location.

Trying to impress customers with expensive furnishings just leads to high operating costs. Be proud of your frugality, make it a part of your culture. At least once per quarter, make a list of all of your ongoing expenses and see what you can eliminate or reduce. I recently noticed that my internet expenses were high and was able to call my provider and reduce my bill by about 50%. That alone may not add up to a high dollar amount but reducing and eliminating expenses regularly will.

So What do YOU Think?