I'd like to stay on the topic of Budget a little while longer ...
I can hear you sigh...
I might be beating a dead horse here, but it is really such an important task that every entrepreneur should accomplish for her/his business (and personal finances too, but that's a different story).
If you read my previous posts you know already I suggested starting with a Vision. A Vision is an outline of where you want to go.
Then you build your Strategy that connects the now with the desired future by covering how and with what you are planning on achieving your vision.
So far that was all very generalized and not really measurable. The most customary next step is that you try to budget our Sales Revenue based on your Vision and Strategy.
After all, without Sales, you have no money and you have no business, it would just be a hobby. So it seems obvious to start with Revenue.
Do you need a crystal ball to budget?
Especially if you are at the very beginning, you just started your business or you are thinking of starting your business, budgeting Sales can be a very hard task, it can be a trap even!
You have to plan the future, but you can’t know the future.
You have no previous Sales data to build up from, you start from zero.
You don’t have a crystal ball or psychic abilities, so how can you plan for the unknown?
It can rob you of your motivation and determination to create a budget. You are not alone, so many of us struggle with it and end up doing.. yes you guessed it...
So let me suggest a different approach.
Let's start budgeting costs (expenses) first
As much as budgeting Revenue is important, I find budgeting costs - especially fixed costs - even more important. Why?
You have to know what your absolute minimum amount is, that you need on a monthly basis in order to keep your business up and running.
In the beginning, when you start your business and you have no revenue you might finance your business from your private savings.
In this case, to know the amount that is required for fixed costs each month gives you an idea of how long you can fuel your business with private money until the business has to generate enough revenue to carry itself or when you are going to run out of savings.
So what are fixed costs anyways?
Fixed costs are not dependent on the products or services produced by your business, meaning: they stay the same if you have zero Sales or 5'000 in Sales per month.
Fixed costs are also expenses that you have to pay in order to even have a business. Fixed costs can be something different for every business. Some businesses may have hardly any fixed cost at all while others have a steep amount right off the bat.
For example, when I started my freelance business back in 1998 my only fixed cost was to set up my limited company (a one time fee of 1,000 Swiss Francs at that time) and a cell phone plan, and I was set. As a Freelancer, I was going to my clients and was working in their infrastructure (desk, chair, computer, and printer) I did not need my own.
Which left me with the only fixed cost for my cell phone plan, about 50 Swiss Francs per month. The same could be true for you if you wanted to start a service based business.
But not always we get away with almost no fixed costs, depending on what business you start, you might have higher fix costs right away. If you plan to have a brick and mortar business, for example, you might need to rent a space for your store or offices.
The rent or lease of that space is fixed costs because you have to pay the rent/lease no matter whether you actually sell anything or not.
Other examples of fixed costs are:
- Utilities like electricity, gas (in your rented space)
- interest (if you borrowed money)
- salary (if you hired help)
- Domain registration for your website
- Hosting of your website
You can see how it is important, especially in the beginning, to keep the fixed costs as low as possible. It reduces stress if you don't reach your Sales goal right away and it keeps you flexible.
I have seen a lot of businesses fail because the fixed costs broke their neck.
The nature of fixed costs is that once you have committed to them, you don't get out of it that easy. Take the example of rent again, you might have signed a lease for 1 year, that means you have to come up with the rent every month for a whole year, even if your business does not reach the budgeted Sales.
By knowing your fix costs, you focus on the absolute essentials and it also gives you an indication for your Sales Budget. The first goal in your budget should be that your Sales cover your fix costs.
If you have low fix costs you may reach that goal quickly or even right away, if the fix costs are higher it may take a little longer.
By knowing your fix costs, you can also calculate how many products, or how many hours of service, you have to sell per month to cover the fixed costs. That gives you a good insight on how to structure your prices for your products and services.
It also shows you when you actually can expect to get money out of your business (a salary) for your own, private fixed expenses that you have to pay as well.
Of course, you have to pay rent or mortgage for your apartment, pay for utilities, for insurance premiums. You have to have money for food and clothing etc.
But these are private expenses and have to be covered from the profit of your business, or the salary you draw from your business.
Don't confuse private expenses with business expenses
a mistake that happens a lot.
The business has to cover its own costs first before you can draw out money for yourself. Depending on what legal entity your business has, you can or you can't draw a salary from your business to pay your private fixed and variable costs.
That means besides fueling your business with your savings to keep it running, you also have to cover your private fixed and day-to-day expenses with your savings.
Can you see now how important it is to know your costs before budgeting your Sales Revenue?
If you have any questions or you need more clarification around this topic, don't hesitate to contact me, I am happy to help. I also offer a service where I teach and support you creating your budget. Check it out here.