Even before launch day one thing is certain: It costs money to start and run a business. We all intuitively know this to be true because we know that simply existing in the world (as a business or individual) comes with expenses. It is one of the biggest barriers many undercover entrepreneurs see between their current lives and their dreams. And while we all know the benefits of getting as much as bang for our buck as possible, even the smallest startups with little to no overhead and minimal cash burn must spend money to grow or stay afloat.
Just like your first steps into #adulting can be financially wobbly, so can the first year (or few years) running your own business. You might have the wisest, most experienced mentors and investors in your court, but there are going to be things that nobody can prepare you to face. Like everyone else, even the most seasoned entrepreneurial vets are limited to their own experiences and can only know so much about what the future holds for your particular startup.
By now, you’re already game to take on the up and down adventure ahead for you and your company. If you’ve followed along with our blog, you’ve learned about raising capital to fuel your dreams, identified which financial statements are your go-to guiding light, and uncovered more than you ever wanted to know about the United States tax code… But in this article we go over the number one thing you can do to be certain the money you spend on your business turns into revenue in your bank account:
How to Build a Budget in Your First Year as a Business
No business leader worth their salt forges ahead without a budget in their back pocket. As you guide your startup to success, this budget will be the roadmap, blueprint, and backbone for your business all wrapped up in one tool. Which is why, when putting a financial plan together from scratch, it’s important to be realistic and continuously consider whether the types of information you incorporate are practical and useful. With that in mind, start off with the basics:
Create a basic budget based on what you do know and can expect
As with any plan, you want to map out what you know before anything else. If you’ve created your own personal budget in the past, this is the part of business budgeting where that comes in handy!
Start by capturing any and all expenses and income:
A major hurdle to creating a budget at a startup is the lack of historical data. Being so new means you lack a consistent baseline of business activities to use in forecasting. You can safely assume certain costs based on the nature of your business and industry, but the only way to get a true foundation is by capturing every single transaction from the get go. I cannot emphasize this enough: If you aren’t diligent about capturing each and every one of your costs, you’re destined to be under budget.
There’s absolutely no way you can plan adequately without a general ledger of your transactions or, at the very least, a business bank account you can use to analyze data to create your baseline budget. From there you can start to see what you’re earning and what you’re spending. At first, there will be a heavy emphasis on day-to-day cash flow management, but as your business grows your financial responsibilities become more and more about thinking ahead.
Identify recurring transactions
As soon as you can, start looking for transactions that happen more than once between any given day, week, month, or quarter. When you start to think about expenses and earnings as part of your ongoing operation you can begin to plan for them on a regular basis. You’ll have three major types of recurring costs to plan for, fixed, variable, and mixed expenses.
- Fixed expenses stay the same over each period. Rent, payroll, insurance, taxes, loan payments are a few example expenses that are common between almost any business budget.
- Variable costs are also recurring on a periodic basis but different from fixed costs in the sense that the actual cost value fluctuates based on different factors, activities, and uses. This type of cost is typically seen in sales, inventory management, contractor/billable hours, or credit card fees that depend on performance.
- Mixed costs are a hybrid of both fixed and variable expenses. Also known as semi-variable costs, these include a fixed rate for service or membership along with a varying cost typically based on usage. The prime example of a mixed cost is a utility bill which has a typical monthly rate for service with added costs based on consumption (heating, cooling, lighting, etc.) during that time.
Do your best to estimate the last two types of costs when budgeting in advance. You can base an approximate amount on the typical rate or an average of the months you have historical data for, but always be sure to go back and retrospectively update when you get the true amount.
By looking at your Profit & Loss (P&L) Statement (aka Income Statement), or even just the transaction history in your business bank account, you can see what type of spending keeps coming up again and again. Add those expenses to your budget and denote which type of costs are steady or fluctuate so you know what needs to be updated regularly.
Exclude one-off costs
Be sure to also look for outliers you can ignore. It’s natural for startups to incur many one-off costs at first that won’t happen again. Budgeting for singular purchases or irregular cash advances doesn’t necessarily help your business on a regular basis and those funds are better spent on your known costs or put away for a rainy day!
Work with this simplified budget to focus on the money you know is entering and exiting your company on a regular basis. When you do reach a full year of capturing transactions, take a look at those twelve months and evaluate: In addition to your steady monthly/quarterly costs, take an average of what you’re spending on one-off costs and add that for each month/quarter as a cushion. There you have a foundation for applying your knowledge and experiences as you grow and learn more about what to expect.
Repetition is your friend:
Track patterns to define your business’s periodicity
In some ways, if you’ve followed the steps above, you will already be tracking repetition within your business activities. You’ll see the repeated costs and incoming revenue and have a good tracking process in place moving forward. However, that data collection and categorization is only half of the budgeting picture. The other half means establishing expectations.
As Merriam-Webster puts it periodicity is “the quality, state, or fact of being regularly recurrent or having periods.” Now, it would be pretty presumptuous for any first-year company to set their periodicity in stone in their first few months, or first year. However, startup leaders and executives should use this as a discovery activity and pay attention to the external circumstances that affect their company periodically.
Instead of writing momentary roadblocks or prosperity off, start learning from those experiences to build awareness about what to plan for:
Image courtesy of happythings.tumblr.com
This ongoing exercise is where you begin to use the past to your unique advantage and look further than the short-term by learning as you go.
This is especially true for seasonal businesses…
Using business seasonality to your advantage
Seasonal businesses cannot compare month to month but instead, rely on that year over year tracking. This means, September 2015 may look pretty similar to September 2014 but nothing like June 2015.
Depending on the business you’re taking on, you may already know to expect seasonal fluctuations. Particularly if you’re selling anything related to the outdoors or retail sales that heat up during summer camping season or the holidays. For many new businesses in emerging industries seasonality can come as a surprise. If you are starting to see trends for seasonality, your first year is incredibly crucial to future success.
Again, a first-year company with seasonality adds double the challenge when it comes to forecast because data is even more limited. Whatever you do be sure to track your own observations incessantly and be as conservative as possible. In the meantime (first year), use industry benchmarks or look at competitors and how their revenue changes.
Plan for sunny and rainy days but don’t decide what to wear just yet
No, that headline is not just a tip you hear when visiting Portland, Oregon…
We keep coming back to this, but so much of what business experience—especially in their first year—is hard to fathom, let alone plan for. Planning is where things get creative and you begin to look at ways to build a relationship between your expenses and your income. This strategizing means forming a balance between what income you have and how you can spend that money to make more of it.
Business is cyclical
The phrase “spend money to make money” didn’t come from nowhere. Your expenses and your income have a very close relationship. More than just spending money to make money, it’s important to identify how each expense ties back to revenue.
Take sales for example. Most businesses have sales representatives to either drive or assist with customer acquisition. Hiring and training a sales team requires an upfront investment. To budget for this correctly, you must think of all the costs associated with adding headcount: salary, benefits, equipment/materials and any costs that are specific to the role. Then, set expectations for how this hire will cover their costs based on the average revenue each sales rep closes.
Ultimately, businesses make spending decisions based on the most educational guess they can make about performance trends and revenue generating activities. However, the savviest leaders know better. They don’t just create one plan…
Create two budgets: best vs. worst case
When it comes time to apply your knowledge toward your hypothetical future financial strategy, it can be useful to think of an IFTTT (if this then that) approach.
You’ll always start by incorporating the recurring expenses. These should not change. From there, you will set reasonable benchmarks and stretch goals for your business performance and use that as criteria for how you decide to spend money. Here’s an example:
Let’s say a business gets a voucher for $1000 a month for an entire year to spend on advertising. They then set an optimistic goal that revenue will jump 25% this year. They also remember that not everything works out the way it is supposed to and are immediately overcome by humility. They set their worst-case benchmark at a 15% loss of ARR (annual rate return) and create a budget for both scenarios:
If they hit or exceed their revenue growth goal they’ll start spending more money on advertising and even increase that budget to double ad spend each month. They will also use that success as an indicator to spend more money hiring an additional sales representative and product team to build new features that are even more competitive and marketable. That additional headcount also means moving up to new or additional office space.
If they were to come up short or closer to their worst-case scenario, they’d use an alternative budget with more conservative spending. They may even consider cutting perks/benefits, headcount, or downsizing their office.
Part of being realistic means tackling any time period with the expectation that it could be a high or a low time for business. Planning for both outcomes with a well-thought pivot plan affords your startup flexibility and reactivity.
Track your pace with these financial analysis tools
In addition to your general ledger and the financial reports you’ll use to track cash flow, income, and expenses regularly, business owners can also rely on their burn rate and cash runway when establishing a solid business budget.
Burn Rate refers to the difference in the cash a company has over a specific period of time (typically a month). So, if a company spends $10,000 a month, their monthly “burn rate” would be 10,000. Once you know your burn rate you can compare it with forecasted income and adjust your monthly spending if you see that your burn rate exceeds what you anticipate.
Cash Runway is the amount of time your company could survive off of its current cash at its current burn rate. So, if a company has $80,000 in cash available on-hand, and a monthly burn rate of 10,000, it’s cash runway is 8 months.
Startups who pay attention to their burn rate and cash runway gain a lot of value in knowing exactly what amount they need to be covering at any given moment. This is useful as a business gains its footing with an initial customer base and has yet to build a consistent revenue stream or sales pipeline. The better you are at tracking your expenses the more accurate your burn rate and cash runway will be.
What Your Spending Says About Your Startup’s Priorities
The way your business spends its money says a lot about its values. You want to build a budget as an accurate representation of how you prioritize each part of your business. Any experienced business analyst will be able to glance at your financial statements and quickly understand whether you’re investing in the long-term or can only see as far as month to month.
A budget is only useful when it’s relevant, realistic, and recognized
You’re not doing anyone any favors when you B.S. your way through this process. Leave all vanity behind and stick with what will help you use the past to think ahead and improve your bottom line.
In the wise words of Jessica Mah “Be transparent about your budget.” Share it with your team and explain where it comes from. Understanding the logic behind budgets will help your employees know how you’re prioritizing and making key decisions. This will, in turn, enable them to think critically when strategizing and planning projects and making day to day decisions.
It’s also not a time to keep your head in the sand. Continue to review and apply new knowledge as you gain it. The small business association (SBA) recommends revisiting your business’s budget on a monthly basis with all key stakeholders. This is a time to judge what types of expenses are working and anticipate upcoming expenses and revenue generation.
Every step you take toward becoming a smarter, more data-driven business is a leap in the right direction and above all else, remember there are many benefits to having a business budget. Not only will it help you manage your expenses and increase your profits as best you can, but your business will also be poised to impress investors and creditors when you need growth capital down the road.