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How to Build an Operating Budget for Your Small BusinessBy: Nan Hawthorne
Summary:
Developing an operating budget for your small business can make the difference between success and failure. What are the various components of an operating budget? Where can you get help? Read on. 
What Is an Operating Budget and Why Do I Need One?
What Goes Into an Operating Budget? Getting Help With Your Operating Budget Related Links Related Content What Is an Operating Budget and Why Do I Need One? When you consider renting a new apartment or buying a home, you look at your available income and savings as an employee to determine if you can afford the move. If you're self-employed, you must look at the cost of running your small business and your expected income to see if such a move is financially prudent. The Dictionary of Small Business defines "budget" as "A document that lists planned income and expense items along with the dollar value for each. A budget is most useful when, at a later date, actual transactions are compared to the budget for analysis and control of future decisions." There are several types of budgets for small business, such as a cash budget, which tracks cash flow, and an expense budget, which allows you to compare actual and budgeted expenses. An operating budget, though, deals with bottom-line issues. It's "an itemized statement of income, expenses, debt service and cash flow during a future period; a projection of the profitability of a business." To put it simply, an operating budget is the plan you use to make sure you have the money to operate your business. It is the plan that "will help you determine the amount of resources you need to get the product out the door or the service to the customer," according to "Build Your Business With A Better Budget." Just as a household budget insures that you will have the money to pay rent, to put food on the table, and "to keep body and soul together" as the expression goes, the operating budget shows whether you'll have the monetary resources to "keep on" doing business. Any business startup is a risk. There is no science that can dependably and accurately predict what you will be able to sell and what it will cost. But a budget is a guide by which you can plan, assess the performance of your business and adjust your operations when the real figures start to roll in. Clearly an operating budget is a tool you can use to prevent unexpected crises in product or service delivery due to lack of cash, credit, tools or inventory. You need an operating budget to stay in business, pure and simple. Go to Top of Page What Goes Into an Operating Budget? Are you serious about operating a business of your own? If you are, you will be wise to dismiss any notions that you can "get by" with little or no planning. Just as you plan construction of a home with a blueprint of its structure and a description of the materials to use, you take the time to make sure your business is on a firm financial foundation so it will not collapse with the first strong breeze. An operating budget is part of any business plan. It is the projection of what it will cost to run your business and what money will be coming in to cover those costs. There are five parts to an operating budget: the sales budget, the production budget, the operating expenses budget, your budgeted income statement and your cash budget. Each of these five budgets should be developed at startup as parts of a short-range plan and a long-range plan. Startup expenses include the costs of licenses and permits, of equipment, and of legal fees. Both short and long-range operating budgets cover the same costs and income categories outlined below, but creating both helps you plan, track, and assess the growth and viability of your business over the near term as well as the long haul. To see what items you might include in your operating budget, see this Microsoft Word Document: Sample Operating Budget at Findlaw.com. Go to Top of Page First, develop your sales budget. As your projection of what you can sell (whether it's chocolate bunnies or housekeeping services), it is the budget upon which all other planning is based. Your market research will help you determine these projections; you will have studied what the demand is for your product or service. The sales budget and its accuracy can make or break your business. If you overestimate sales, you may spend too much money on your product. You may wind up with a storeroom full of chocolate bunnies going stale. On the other hand, if you underestimate your sales, you may find yourself unable to deliver your product or service in a timely manner. You may have more houses to clean than you have time to clean them. In either case, your business will suffer. Go to Top of Page Production Budget Just as your sales budget provides plans for how much you can sell, your production budget accounts for how much it will cost to produce it -- including the cost of raw materials, tools, labor, and overhead. Overhead is comprised of "the expenses and costs that are not directly associated with the production or sale of goods and services. (It includes) the normal costs of being in business, such as office, rent, utilities, insurance, advertising, accounting and legal expenses," according to Dictionary of Small Business. For example, your production budget for chocolate bunnies might cover the chocolate ingredients, packaging materials and the cost of paying a chocolatier's salary and benefits as well as rental of a commercial kitchen, the cost of cooking fuel, the cost of pots and pans, the cost of liability insurance, the cost of licenses, and so on. For your housecleaning business, it might include the cost of cleaning supplies, tools, and transportation as well as advertising your service, being bonded, getting insured, and so forth. Production budgets are keyed to time frames when the costs will be incurred. You may sell most of your bunnies right before Easter, but you may need to purchase the supplies at another time of the year. You may need to pay salaries throughout the year. If you don't estimate your production costs accurately, you may wind up losing money. My husband and I had an odd-jobs business 20 years ago. One of our jobs was to haul away a farmer's junk pile. We were sure we charged him enough, but his enthusiastic agreement should have told us something! The truck rental was higher than we expected, and we had to pay to dump his garbage. The only thing we got out of the deal was an old songbook I remembered fondly from Methodist Camp. And that was one expensive songbook, when you consider what we lost! We had sadly underestimated our production budget and, as a result, undercharged the customer. Go to Top of Page Operating Expenses Budget The operating expenses budget is really just one of the budgets that make up the production budget. It covers regular business expenses. Just as a household budget projects the cost of rent (or a mortgage), utilities, groceries, and so forth, an operating expenses budget for a small business projects the cost of rent, salaries, utilities, insurance, and other ongoing costs. Usually the operating expenses budget is divided into the various areas of doing business, such as advertising, human resources, research, and administration. The sales, production and operating expenses budgets are the basis for the budgeted income statement. You need to have developed them before you can prepare your income statement. Go to Top of Page Budgeted Income Statement The budgeted income statement is where the preceding budgets are assembled so you can check costs and incomes to make sure you are not spending more than you are making. The income statement covers a given period. It is a tool for planning, but it is also a tool for monitoring how closely real costs and income compare with your projections. The statement can also "keep you honest" -- that is, it can help you make decisions about priorities when an unexpected need (or temptation) to spend outside the budget comes along. For instance, if you were managing the production of the chocolate bunnies on your own and begin to think about hiring a chocolatier, the fact that you did not budget for salary and benefits should encourage you to consider how the decision will fit into your plan. You may decide to delay that hiring until you draw up your income statement for the next budgeting cycle. Go to Top of Page Cash Budget The difference between your receipts (that is, the money you bring in through sales) and your expenses is "cash." In a household situation, it is what's left in your checkbook register after all the bills are paid and groceries are purchased. In a business, it is, in a sense, the leeway between breaking even and making a profit. But it goes a step further, since some of that leeway will likely go back into the business to replace broken or old equipment, to do special research, to develop new products, and so forth. You use your cash budget to project the cash you may required for unexpected needs. It need not be coins and currency, but it can be money in a bank account or anything that can readily and dependably be turned into cash. Your cash budget makes sure you don't tie up your cash in other uses so you end up, at some point, "strapped" for cash. For example, let's say you break your leg and suddenly cannot do any housecleaning. You will not have budgeted for salary to hire someone to take your place for several weeks. But, if you have sufficient cash on hand, you can do that -- probably a better option than risking losing regular clients to another housecleaning business. Go to Top of Page Getting Help With Your Operating Budget The following resources can help you develop your small business startup, short-range and long-range operating budgets.
Made possible by a grant from the American Express Foundation.
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