Budgeting in Small Business

Budgeting in small business can be important for personal budgeting because many householders run a part-time or full-time small business. If you own your own business, it’s very difficult to sort out your personal budgeting unless you also budget in your work.

The Challenges Small Business Owners Face

For many years, I worked as an accountant and business coach helping small businesses with their finances and profits. In my experience, very few of them focused on getting their financial house in order.

Often, people set up a small business because to gain more freedom. You don’t have a boss telling you what to do. You can choose your own hours, the services you offer and how you go about helping your customers.

But instead of finding this freedom, many business owners struggle:

• Working long hours
• Piles of paperwork (digital or on the desk)
• No regular pay check
• Poor financial rewards
• Taking on business debt
• The risk of making a loss
• Finding the money to pay taxes
• The risk of losing your family wealth (including the house)

It doesn’t have to be like that. There are success stories. And one of the keys to achieving that success lies in the principles for budgeting in small business.

Budgeting in Small Business

I recommend a different way for budgeting than most business use. For those business owners who make a budget – and many don’t – the usual way of doing it is:

• Estimate income
• Deduct overheads, taxes, and other costs
• See how much money is left to pay yourself and for profit

In my accountancy training, this is the way we were taught to do it. So, I don’t criticise business owners for using this method. It’s how I used to think. But then I came across a different strategy:

• Estimate business income
• Pay yourself first
• Put money aside for taxes
• Deduct overheads and other costs
• See how much money is left for profit

This is a kind of halfway house to the method I recommend now – see details below. But before we get there, let’s look at paying yourself first.

Why Pay Yourself First?

Quite a few books on personal finance recommend you pay yourself first. For example, The Richest Man in Babylon – a book of parables about how to become wealthy – tells us to save 10% out of our income. First put the 10% to one side than then restrict your spending to the remaining 90% of your income.

You can argue the exact percentages, but the principle is this. Rather than paying yourself what’s left over after paying everyone else, you first pay yourself. In the context of a small business, you’d budget to pay your monthly wage as a priority over paying your overheads. If you don't pay yourself first, you will probably not take the decisions needed so you can pay yourself last.

Yes, there are a valid questions. What if this leaves you with too little money to cover your overheads? What about your tax? Any system for budgeting in small business must provide logical answers to these questions. And I’ll be covering these in a later article. Here, I’m just giving you the bird’s-eye view.

Profit Budgeting in Small Business

As I mentioned, the halfway house is this:

• Estimate income
• Pay yourself first
• Put money aside for taxes
• Deduct overheads and other costs
• See how much money is left for profit

We can take this further, so we set profit targets rather than seeing how much is left after paying overheads. Instead, we limit budgeted overheads:

• Estimate income
• Put your budgeted profit to one side
• Pay yourself your wage
• Put money aside for taxes
• See how much is left to pay overheads

We’ll tackle how to manage your overheads later. For now, the key point to understand is that you have turned the budget on its head. Making profits and paying yourself a wage come earlier in the budget. Overheads drop down the priority list. This does not mean you don’t pay your suppliers. But it does mean that you limit your expenditures to what the business can afford – after paying you.

Cash Flow Budgeting in Small Business

Cash flow is king. It’s vital to focus on money in the bank rather than just theoretical profit. Several times I had clients sitting the other side of my desk saying, ‘How could I have made a profit? I don’t see my bank balance going up.’

One of the main reasons you must prepare annual accounts in terms of profits is so that the taxman can calculate the profit taxes you pay. When it comes to managing your business, cash flow is equally – maybe more – important. But it helps to understand both ways of measuring your business performance: profitability and cash flow.

Financial Goals for a Small Business

Wrapping up this overview of budgeting in small business, let’s list some useful financial goals.

• Estimate your business income
• Budget to make profits a priority
• Budget to pay yourself a regular wage
• Budget so you set aside money for taxes
• Estimate how much is left for business overheads
• Plan how to limit your overheads to the budgeted amount

As I said, this is just the overview. We’ll look in more detail in other articles about how to achieve these aims in further articles.