Building a Budget 101

Building a budget from the bottom up is the best way to help control expenses and channel income where it's needed most. Doing it from the ground up means starting at the lowest possible level of detail so that you can account for all the critical areas in your business: revenues, cost of sales, advertising, rent, maintenance, utilities, and other overhead expenses.

"Budgeting is simply goal setting. If you believe in the strength of written goals, budgeting makes those goals even more powerful," says Ellen Rohr, president of Bare Bones Biz, a small business training and consulting company. "You flesh out your goals with numbers, dollars, and percentages, and you gain clarity. The more clarity you have about what you want, the more likely you are to create it."

Building the budget

As you're putting together your budget, Rohr advises utilizing "your imagination, a pencil, a columnar pad and a calculator. You can also use an Excel spreadsheet, which is a good tool for doing the math. Your accounting program may have a budgeting feature. Start with expenses; then, create a top line—sales—big enough to cover those expenses, and leave the desired amount of profit. If you have past data, refer to it, but don't be bound to it. If last year didn't reach your expectations, don't use the data again. Consider what you want and start there." Here are the basic budgeting steps Rohr recommends:

• Create a reasonable chart of accounts—The chart of accounts should reflect your business. Your accountant may encourage you to use his or her chart of accounts, which makes it easier for them to do your taxes. He or she should accommodate you and your business by helping you create a chart of accounts that is specific to your business. In creating the chart of accounts, consider your main areas of sales. Do you sell service jobs? Commercial and residential? Services and materials? Look at your business, and nail down a few (no more than three) main departments. Line up the sales accounts, and then consider the direct costs (COGS) for each one. It's good to be able to see the "big rock" numbers associated with sales, labor costs, and material costs per department. There is an art and science to this. When it comes to the balance sheet accounts—assets, liabilities, and equity—make sure the accounts reflect your assets, liabilities and equity. Keep it simple and elegant. If you have to ask, "what's in this account?" consider renaming it to be more reflective of the contents. For instance, identify your main checking account like this: 1-1010 Commerce Checking 4589. The numbers can be the last few digits of the account number. Using account numbers makes it a lot easier to find your way around the reports, and you can increase the accuracy of your data input. (For a simple example, check out this Sample Chart of Accounts at NetMBA.)
• Simple budgeting involves goal setting for sales and expenses (costs)—Start with account number 4-1000 and work through the rest of the expenses. Of course you can add other expenses. This is just a starting point. More sophisticated budgeting involves the balance sheet items—assets, liabilities, and equity (accounts 1-1000 through 3-9000.) If you're new to budgeting, start with sales and expenses. Address the other items with your accountant after you have done that.
• Find a "Budget Buddy"—Doing your budget with someone else is a great idea. Two sets of eyes will catch more math errors. Two brains will help you think out your assumptions. And making an appointment with another person to work on the budget will discipline you to keep that appointment. Budgeting is easy to put aside because it's not an urgent activity. Who should be your Budget Buddy? Another business owner is good, or you can work with one of your employees on the budget. Don't be afraid to share your financial information with a key employee. Their financial literacy makes them more valuable to your organization.
• Dealing with the sales line—There are two ways to approach the sales line of your budget:
  • Set a sales goal, and work from there.
  • Fill in all your projected costs, and then see how much sales will have to be to cover costs and leave your desired profit.

Either way works. If you start with the sales line, and there is not enough on the top to cover all the expenses you anticipate, you can go up to the top line and change your budgeted sales to make it work. Remember, your budget is an estimate. It's an educated guess. You can always move the numbers around.

• Work your way down the list of costs and make your best guess—Reference your income statement, tax returns, and check register to see how much you have spent on expenses in the past.
• You can fill in the budget for the whole year, or month by month—Month by month is a more usable format when it comes to checking actual performance to budgeted numbers.
• Remember, the budget is just goal setting—It doesn't need to be bound by strict accounting rules. You can budget for expenses you haven't incurred yet. For instance, if you want to set aside money for buying a new truck, you can budget for it first, and then buy it once you have the money saved.
• Keep a Budgeting Log—You're going to pull some of your budgeted numbers from thin air. Write down notes to yourself as you come up with the numbers for your budget. When you refer to your budget in the months to come, you may forget your assumptions—write them down in your Budgeting Log.
• Go with what you know—John Young, venture capitalist and marketing maverick, offers this great piece of advice: "Don't put down budgeted numbers that you know won't happen. For instance, if you know that your insurance costs are going to go up this year, don't put down the same dollar amount as you paid last year. If you don't know the increase amount yet, find out or put in an increased number from last year. But don't put in the same number, because you know that won't be it."

Most important, Rohr says, "Don't bury your budget in a drawer once you consider it 'done.' A budget is a viable goal-setting, and getting, tool. Each month, compare your actual performance to your budgeted performance. Even better, check mid-month. If you are behind in sales, take action to crank up sales and cinch down expenses. If you don't refer to your budget until after the month is over, you may miss the opportunity to course correct. If you miss your goals, the goal police won't arrest you. If things aren't meeting your objectives, you get to adjust, refine, revisit, and change things."

Source: “Building a Budget from the Ground Up," Trendline