Budgeting is essentially a review of financial information from the past to predict the future performance of your business and manage business resources accordingly. When newbie business owners finish their business plan, they have, in effect created their first budget, using what they believe business conditions to be to predict the revenues and expenses of their business. Once the business has been established and running for a year, business owners enter their second year with a little more realistic view of how much they can expect to earn and spend in the course of their business, and can adjust costs and prices accordingly.

In the very early stages of your business, you’ll likely want to keep your budget simple. As your business progresses, and as you become more financially and technically savvy, you can prepare more detailed budgets.

In the beginning, there are a few basic concepts you must understand:

Variable costs – These are costs that fluctuate based on your sales. For example, if you’re running a pizza business, the more pizza you sell, the more your costs for cheese, crusts, etc. goes up. Fewer sales means lower variable costs.

Fixed costs – These are costs that don’t fluctuate based on sales, such as insurance, rent, payroll, etc.

Break-even point – This is the point where your sales allow you to break-even with your costs. Finding this point is important in figuring out the pricing point for your products or services.

Gross profit – This is your total sales, minus the cost of producing your product or service. It doesn’t include the cost of taxes, payroll or interest payments.

Net profit – This is your profit after subtracting taxes, payroll and/or interest payments.  Most simply, this is the money you have leftover after paying for all your business related expenses.

By understanding these basic terms, you’ll be able to generate a budget that shows your estimated costs of doing business, the price you need to charge to break even and make a profit, and how much you can expect to earn from operating your business.

For budget beginners, here’s a simple worksheet you can use as a template as you prepare your budget.

Total Revenue

Sales Revenue

Interest Income

Investment Income

Other income

———————————————————————————————————–

Expenses

Accounting

Payroll

Legal expenses

Vehicle expenses

Interest on debt

Supplies

———————————————————————————————————–

Total revenues

Total expenses

Gross profit

Net profit

While there are any number of additional expenses you could tack on to the report, this gives you a basic template you can start from.

Additional tips

Here’s a few budgeting tips for small business owners:

Get the software. If you’re doing your budget on your own, invest in some software. Microsoft’s Excel is an easy to use and reliable tool and is used by both mom-and-pop stores and Fortune 500 companies. Also, most accounting software packages have an application you can use for budgeting. The great thing is that most of these applications have tutorials that will help guide you through the budgeting process.

Look around. Small business owners should do a thorough review of their industry and speak with business owners in similar fields to determine what budget conditions are like for them. You can also take a look at the IRS website to help you see what portion of your revenue will likely have to be budgeted to cover cost groupings. You probably won’t get an exact template for your business from this research, but you will get a general direction that your budget needs to take.

Learn to love spreadsheets. If you don’t already use spreadsheets, learn how and use them to estimate how much of your revenue will need to be used to cover your supplies, labor, rent and other costs. Spreadsheets are an excellent visual tool that can give you immediate access to the information you need to successfully monitor and forecast budgets.

Design your budgets with a cushion for adversity. Don’t expect your business to follow the budget you create down to the last penny. Leave yourself some leeway for cost overruns and unanticipated events. This is particularly important if you’re expanding your business or hiring more help, as unforeseen costs from these activities can and do often arise.

By designing your budget with a cushion, you can ensure that you’ll have a soft landing should adversity alter your plans.

Be on the lookout for cost cuts. Constantly be looking for opportunities to reduce costs.  Even if you don’t immediately take advantage of them, in the event that you need to drastically reduce costs, you’ll have some immediate ideas of where to cut.

Other cost-lowering maneuvers include delaying purchases until a new billing cycle begins and to carefully examine payment terms your creditors and suppliers offer to find the plan that’s best for you.

Also, be on the lookout for tax advantages that make purchases or deferring purchases advantageous. Keeping in touch with your financial advisor about these potential moves throughout the year is recommended.

Revisit the budget a few times per year. Just as weather forecasters periodically update their weather forecasts as new information becomes available, so must business owners revise their budgets as business conditions change. It’s important to keep a close watch on income and expenses and adjust accordingly when the figures skew far from your estimates, it’s time to sit down and run the numbers again.

There are many variables that can change in the course of a fiscal year, making it neccessary to revise your projections. For example, in recent years the cost of gasoline has varied greatly, and businesses involved in transporation are highly impacted by changes in this cost. A big shift in the price of gasoline could lead a transportation-related business, such as a delivery service or cab company, to need to revise its budget to account for increased costs or to find a productive use for savings created by sinking prices.

Mastering the budgeting process can be a valuable tool in helping you quickly assess your business’ profitablity and the actions you need to take to reduce costs or increase revenue to keep it in the black.

Although mastering pricing is crucial to business success, few new entrepreneurs grasp the concept of setting prices that are both competitive and capable of sustaining business.

Service based businesses

If you’re running a service-related business, two major concepts you’ll need to master are how to set prices and how to bill your clients. Having reasonable, well-thought out rates is important to getting jobs and making sure you turn a profit from them. Knowing the right way to bill your customers is also important, as it helps to ensure both the profitability of your venture and your professional reputation. Amateurish billing can result in lost profits, and lost confidence from clients and a less than stellar reputation in your business community.

Service-based entrepreneurs or freelancers can have a difficult time determining what rates to use when they bill for work, as assigning value to time is more abstract that assigning value to an actual item or product. When setting rates, you should remember that these rates need to be sufficient to cover your overhead and yeild profits. Market pressure from competition can also exercise an upward or downward influence on your pricing.

Setting hourly rates

Many sole proprietor service businesses work out a billable hours formula to help them set hourly rates. The formula essentially takes the business owner’s target annual salary or profits, adds overhead costs and desired profit to the target and divides the total by the number of billable hours the owner feels he or she will work during the year. The result is the hourly rate. A modified version of this can also be used to determine a billable hours rate for businesses with multiple employees.

When determining your hourly rate, you’ll need to make a realistic assumption of how many hours you will be able to work during the year. For example, if you’re running a part-time consulting business and expect to put in about 20 billable working hours per week on your business, you’d end up with 1,040 billable hours per year. Remember, that not all of the hours you put into your business will be billable, as some time will have to be spent on administrative or marketing work.

Here’s a basic example of how a small business owner may use the billable hours model to determine his or her hourly rate:

John has started a home repair consulting service and wants to determine an hourly rate. John wants to make $40,000 per year from his work and expects to have annual overhead costs of about $15,000. John also wants to make a 10 percent profit. This necessitates John making $66,000 per year. John’s doing his work full-time, so there’s potentially 2,080 billable hours. However, John estimates he’ll spend about 20 percent of his time on marketing and administration, leaving him with 1,664. To make his goal, John will need to charge $39.66 per hour for his work.

Just because you’ve decided that you want to charge $39.66 per hour for your services doesn’t mean that you’ll receive $39.66 per hour for your services. The health of the local economy, as well as industry standards and competitors rates can exercise influence on your rates.

When starting your business, try to do a little research into what the industry standard is, and how much your local competitors are charging. When you’re just getting off the ground, you may want to charge slightly less than the industry standard or local rate to entice customers. Don’t drop the rate too low, however, or you may give the impression of low quality to potential customers.

Billing customers

When billing customers for a service, you can use three main options, flat fees, hourly billing and retainer arrangements.

Under a flat fee agreement, you and your client will agree to a set price for a specific project. Regardless of how many hours the project takes, the agreed upon fee is the compensation you will get, barring certain circumstances that may be agreed upon in the service arrangement between you and the client.

When setting a flat fee, it’s important to estimate the time necessary to compelte the project and also consider your billable hours estimate as discussed above. Contractors typically discount their hourly rate somewhat for large projects.

The flat fee arrangement can be beneficial for clients and contractors. Clients get to know the full cost of the service up front, and contractors are freed from the administrative task of having to keep up with hours worked in order to bill the client. Also, with flat fee billing, working efficiently is encouraged, spurring the contractor to find ways to make the project as quick and efficient as possible.

Small business owners can come out on the short end of the stick through flat fee billing if they’re way off the mark on estimating the time necessary to complete the project or if the scope is vague and the client continually asks for changes or expansions of the project. When setting a flat fee for a project, you need to make your estimate of the amount of work involved as accurate as possible, and you also need to nail down the scope of the project with the employer and make provisions for billing for work outside the scope to avoid getting caught in a project that ends up being unprofitable because of scope creep and schedule overruns.

Hourly billing is pretty straightforward. You quote the client an hourly rate. You do the work and keep up with the time involved and then present the client with a bill. Billing by the hour can prevent you from getting shafted on a project that isn’t well-defined and ends up taking longer than you thought it would. However, if the client is presented with an unexpectedly large bill at the end of a project, or if the client doesn’t feel that he or she has gotten value for the hours worked, conflicts may arise.

In a retainer billing arrangement, the customer will pay an ongoing fee, most likely on a monthly basis, to retain the service provider to perform certain services. Services that go beyond the agreed upon retainer arrangement may be billed for separately. A retainer arrangement is good for customers who will likely need services on a regular or semi-regular basis. For example, an accounting company may choose to retain the services of an IT contractor to maintain its web site and computers or a real estate rental company may retain a pest service to perform regular work at its properties.

When devising a retainer agreement, estimate how many hours you believe you’ll need to spend on the client’s project and also include your overhead expenses, such as supplies and parts. Don’t be afraid to ask your client questions about the amount of time their in-house staff or previous contractor spent on their needs and other questions that may help you come up with a realistic idea of how much time and materials the job will consume. The more accurate your estimate is, the more profitable the job is likely to be.

Few business owners come into business with an instinctual knowledge of what prices to set and how much to bill. For most it’s a skill that comes with experience as they complete jobs and learn more about the work and materials that go into differing jobs. However, by keeping the lessons above about pricing and billing in mind, you can reduce your learning curve and get to the point where you’re able to make accurate – and profitable – prices and billing.

Some people may have enough money to start their own company without having to approach people for a loan. That may not be the wisest move for them to make. Many people also believe that they do not have enough money to start their own company and so they put off opening their business until they can get enough to open their business. If you find yourself in that position there are a variety of things you can do now to get your business running without having to wait years for you to get enough self funding.

The first step you may want to take is to look for investors. These are people that you can convince to give you money for your company in exchange for a percentage of control in your company or a percentage of profits. The good part about this is you will still be able to keep your own available money.

That money can then be used in other ways than to just invest into the company. The bad news is that if you aren’t careful, you may wind up giving away more control of your company than you are able to retain due to having to take money from these people. If you are to take on investors, always make sure that there is no way that they will be able to have more than 51% control in your company. If they have more than you do, then they have a controlling share in your company and may force your company to head in a direction you would not want. Even worse, they may force you out of the company. If you feel as though that would not be possible, then you may not want to get investors and to search for money elsewhere.

The next step that many people take is to go to their local bank and to apply for a small business loan. The money that you get from there will have an interest rate based upon your credit. Many institutions have government backed SBA loans but they will want you to fill out many forms so that they can verify that you are going to use the money to start up a small business.

Be prepared to bring many financial documents both commercial and personal as well as a copy of your business plan. The good news is that after you have finished completing all of the required forms and producing all of the information that they need, your lender will send off your application to get processed by the government. This could take a while though but it would give you time to finalize your business ideas.

You could also apply for a personal loan for your business but this will not be backed by the government. This is recommended if you feel you cannot wait for the government to process your loan and you need the money now. The interest rate varies and you could end up paying more for this loan than for the government backed one.

There are also government loans based upon your background, location, and the type of business that you are planning to open. These can be quite competitive. You may also want to check your local non-profit organization about getting loans for your business. Some states and cities also give loans to companies that are willing to start small businesses inside of their limits.

The last thing you should do when opening your own small business is to use your own money. Invariably when you open the doors to your company, you are going to realize things that are wrong. It could be something simple such as needing a new sign for the window to complicated things, like needing to install a rotating door. That is where your money will come in. After the building has been financed and the major purchases have been made you can use your money. If you use the loans that you received earlier for your company, you will be wasting the loan. It will also be useful when applying for one of the loans because the more money that you are able to have on hand or in the bank, the more likely the bank is to loan you the money. If you use all of your money before to finance the building or purchase equipment and then apply for the loan, the bank will see that you have no liquid assets. That will raise their wariness about loaning to you and may cost you the loan.

There are many different ways to go about finding financing for your new small business . The most important thing is to get as much information as you can and to build up your assets before approaching anyone to invest into your company.