Small Business Budgeting for Beginners
If you’re wondering what it will cost you to start a small business or how much money you’ll need to operate your company once you open your doors—creating a basic two-part budget is the best place to start. You don’t need to be an accountant to create a simple financial document that will help you outline your expenses and get started turning your business dream into a reality. Here’s how.
Startup vs. Operating Budget
How much money do you need to spend to create your company, and how much will you need once you’re up and running? You can create one master budget document that includes your pre-launch expenses and ongoing operating expenses once you start selling, but to make it easier to find out what it will take to launch vs. run a business, you can create two separate calculations to be combined into one master budget later.
Creating a startup budget helps you understand how much money you’ll need to raise before you open your doors. Once you have that number, if you think you can raise the money to launch your business, you’ll then want to know what it will take to keep your company running.
Creating an operating budget lets you see how much you’ll need to spend to make your product, advertise your business and pay for the general costs to run a company. This will let you see how much you’ll need to generate in sales to first break even—and then make a profit.
Pre-Launch Startup Budget
Your startup costs include a number of expenses common to most small businesses. These include:
•Local business license
•State permit or license (if necessary)
•Post Office box
•Business cards and stationery
•Incorporation fees (if you incorporate)
•Professional fees (accountant, lawyer, graphic designer)
•Office furniture, equipment, software
•Phones and Internet
Notice that these expenses don’t include the materials and supplies needed to actually make your product or service. Even if you start making your product before you launch, these expenses will still be part of your operating budget, because they will generate revenue for you. If you need to make inventory before you start selling, you can include materials and supplies in your initial pre-launch budget. This will let you see how much money you’ll need before you open your business. But keep in mind that if your business takes off, you’ll shift where you put those expenses later.
If you hire employees to help get the company up and running, you’ll need to decide how you want to classify their expense. Finally, if you use credit to launch your company, the interest you pay on a loan or credit card debt is part of your startup expenses.
Post-Launch Operating Budget
Many small-business owners hope to operate their companies using sales income to pay their bills, almost from day one. In reality, it usually takes months (and often more than a year), for even a home-based business to start generating enough sales to pay the monthly bills. Even if people start knocking down your door to buy from you the day you open, you’ll still need to spend some money or use some credit to start your business before you can start selling and bringing in money.
Once you start your business, you’ll have two main types of expenses. Your overhead expenses are those related to running your company even if you don’t sell a single item. These include costs such as:
•Phones and Internet
•Office utilities (lights, heat, air, water)
•Employee salaries or wages
The other type of expense you’ll have is manufacturing expense. Manufacturing expenses include the costs to actually make your product or deliver your service. If you offer a service, such as consulting, you classify the direct cost to deliver your service (such as travel expenses for a consultant) as manufacturing expenses. You won’t have these costs if no one orders from you. Examples of manufacturing expenses include:
•Materials and supplies to make your product
•Labor directly related to making your product or providing your service
•Maintenance on equipment used to make your product
•Utilities costs for the manufacturing space
•Storage or warehouse space
If you start a catering business, for example, your manufacturing expenses would include the costs to service each party. You’d include the cost of the ingredients to make the food, the staff who prepare and serve the food, the cost of transporting the food to the event, and any other expense related to that one event.
Paying Off Startup Expenses
Although some of your pre-launch expenses won’t occur again once you launch, you need to pay for them using the revenue you generate once you launch. You do this by deciding how soon you want to repay your startup costs.
For example, if you spend $12,000 on starting your business, you can add a $1,000 per month overhead expense to your annual budget. That $1,000 monthly expense won’t appear in subsequent annual budgets. You might want to pay off your startup expenses over a three-year period. To pay off a $12,000 startup investment, you’d divide $12,000 by 36 months and add a $333.33 monthly overhead expense to your annual budgets for three years.
How soon you should pay off your startup expense depends on how long you can carry debt on your credit card, how soon a lender or an investor wants a payback or how much profit you start making.
Don’t Get Too Complicated
As you research how to create a small-business budget you will come upon terms and phrases such as “fixed vs. variable expenses,” “general and administrative costs,” and “cost of sales.” These are important concepts for people running a business or those launching a large business. If you’re just looking to get an idea of what it will cost you to start a business and what it will take to operate the business, keep things simple at first.
Lysa’s Gift Basket Business: A Case Study
Lysa decides to start a small gift-basket business. She wants to know what it will cost her to start the business and what her sales will need to be once she starts running her company. This will help her decide: a) if she has enough cash or credit to start the business at all; b) if she will make enough money to pay herself the salary she wants.
After totaling her pre-launch expenses, including the cost to make a variety of sample baskets to photograph for brochures and her website, she determines she’ll need to spend $600 to launch her company. She’ll use her personal computer and phone and opt for a low-cost business website. She has a friend who will help her produce her brochure and take photos of her baskets. If she puts all of her startup expenses on a credit card and carries the balance for one year at 20 percent interest, that’s another $120 in startup costs. She estimates her monthly overhead expenses once she launches her business will be $120.00.
Her cost to make a small basket is $8; a medium-sized basket is $14, and a large basket $24. She estimates she will sell 50 small baskets per month, 30 medium baskets and 20 large baskets (100 baskets per month at an average cost of $13).
Her total manufacturing cost for these baskets will then be $1,300 per month. Lysa wants to pay back her $720 initial (startup) investment in one year, so she needs to add $60 per month to her monthly expenses. She wants to earn a personal income of $3,000 per month the first year.
So, each month, Lysa will spend:
$3,000 per month in salary
$1,300 in manufacturing expenses
$120 in overhead expenses
$60 per month in startup cost payback
Total Monthly Expenses = $4,480
This means Lysa will need to sell her 100 baskets for $44.80 (on average) to make her business work. She’ll have to charge different prices based on the size of the baskets, but she’ll need to cover her monthly total expenses and desired profit (salary) with her revenue from these baskets.
After doing some research, Lysa realizes that she can’t compete with the other gift-basket companies in her area if she charges these prices. She will need to: a) cut her expenses; b) increase her sales; c) take a smaller profit (salary) to make her business work.
Lysa’s options include changing the items in her baskets to reduce the cost, lowering the cost of the items by finding better suppliers or buying in bulk, paying back her startup expenses over two or three years, generating more sales, or taking a smaller personal income.
Let’s say Lysa can get her average manufacturing cost for a basket from $13 to $10. If she can increase her sales by 25 baskets per month, her total manufacturing cost will be $1,250 per month (125 baskets X $10). She decides she will take a personal salary of $2,500 per month.
Let’s run the numbers again…
$2,500 per month in salary
$1,250 in manufacturing expenses
$120 in overhead expenses
$60 per month in startup cost payback
Total Monthly Expenses = $3,930
When Lysa divides $3,930 by 125 baskets, she sees her selling price is now $31.44 per basket, on average, which makes her competitive with the other local gift-basket businesses. And, her cost-per-basket will only decrease as her business grows because each additional basket will absorb some of her overhead costs.
Determining her startup and operating expenses in advance will help Lysa make a much more informed decision regarding whether or not she should start her business before she risks one dime.
Don’t Bet Money You Don’t Have
Many small business fail in less than three years, and a large percentage fail during their first year of operation. Determine in advance how much money you can afford to lose and close your business when you hit that number. Resist the temptation to throw good money after bad by trying to “pivot” or come up with a new way to market a failing business. This is fine if you have the cash to risk, but not if you have taken out a second mortgage on your home, tapped retirement income or racked up credit card debt.