Managing the Money (Part 6) – Budgeting

In previous installments of this series, we’ve been talking about how to get more money into your business – through loans, investors or by going public. But bringing money in is only half the story; you also need a plan for how you’re going to spend that money. And that’s where budgeting comes in.

A business budget is a plan that details when and how you expect to receive and spend money. The revenue and expenditure projections normally cover a period of a year (the company’s fiscal year, which might or might not correspond with the calendar year). Of course, unless you’re psychic, you’ll probably come in over budget on some items and under budget on others, but the point is to have a roadmap so you have an idea how much money you’ll have and what you’ll use it for. Line items should be detailed, but not overly detailed. A typical line item would be “Office Supplies” – there’s generally no need to break it down further.

At the end of the year, you compare the budget to your financial statement, which shows the actual record of your income and expenses. That helps you to adjust the next year’s budget accordingly. But you shouldn’t wait an entire year to find out whether your budget is working. In addition to the annual budget, you should also have a monthly budget to help prevent getting into a cash flow crunch.

Staying solvent

A key factor in staying solvent is to err on the side of underestimating your projected revenues and overestimating your projected expenses. You should also have a contingency fund in your budget for unforeseen expenses. This is different from a petty cash fund for small, miscellaneous expenses. A contingency fund is designed to handle large outlays for things like damage to your capital equipment that isn’t covered by insurance.

Fixed costs and variables

You’ll have to budget for both fixed costs and variable costs. Fixed costs are things such as an insurance payment that you pay in equal installments every month or the rent on your building. Variable costs are things like your power bill or water bill that vary from month to month, depending on how much you use. Fixed costs are obviously easier to project, but you may also need to take into account rate increases and inflation. When budgeting for salaries, you need to consider whether employees will get raises or whether you’ll need to hire additional personnel during the year.

Revenues, expenditures and profits

It’s not good enough (although it’s obviously important) for your revenues to cover your expenditures. You’re in business to make a profit, so you need to have an idea of your targeted profit for the year. Your revenues must equal your total expenditures plus profits. One of the first steps in creating a budget should be to determine what you want your net profit to be. Then you look at what the cost (expenditures) will be, and this tells you how much you’re going to need in revenues.

How do you estimate revenues? If your business is brand new, you’ll need to research other similar businesses. If not, you can use past years’ revenue figures and adjust for any factors that might make this year different (trends, new customers or loss of previous customers, and so forth).

Review and revise

A budget is a guideline, but it’s not (and can’t be) set in stone. Unforeseen circumstances may prevent you from always sticking to the budget. You should review the budget periodically (such as monthly or quarterly), compare actual vs. budgeted figures and amend line items accordingly, especially during volatile times.

If your revenues are lower than anticipated, look at your budget to determine how you can cut expenses. Which items are essential and which aren’t? Which items might you be able to get at a lower price if you shop around? Which items can you cut back on without eliminating them entirely?

If revenues are higher than anticipated, look at where the extra money would be best spent. Do you have debt that you can pay off more quickly, saving money on interest? Should you expand the business? Should you raise employees’ salaries to reward them for the increased revenues? Should you add more perks to help attract high quality personnel? Should you put the money away in reserve so you’ll have a cash cushion in case revenues fall below expectations later?

Summary

A budget is an essential business document that helps keep you on track financially as you grow your MSP. One expense you must not forget to factor into your budget is taxes. Next time, we’ll talk about tax planning for small and medium MSPs.

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