If you’re planning a new business, it’s always fun to dream about where you’re going to be in a few years.
But, to be successful, you’ve got to build a profitable business. That means making sure that you’re spending less than you’re making—unless you’ve got a big pile of money from investors. Even if you do have lots of cash on hand from investors, your goal is still to turn a profit eventually. All of this means creating and managing your expense budget.
We’re talking here about the “expense budget,” but you could also call it a spending budget or an expense forecast, or even projected expenses. All of these labels mean the same thing, so just choose one that works for you and move on.
Your expense budget is one of the keys to good management. Set your budget and then track what you actually spend against that budget. Review the results and revise the budget as necessary. I’ll talk more about how to do that in a bit.
The important thing to remember with budgeting is that you’re making educated guesses, just like every other business owner out there. You don’t need to have a fancy MBA degree or tons of business experience to create a solid budget, and you don’t have to be a fortune teller either. In fact, it’s really very similar to a budget that you might have for your personal finances. Armed with a little knowledge and advice, you’ll be creating an expense budget in no time.
Your expense budget is an important part of your overall financial plan for your business. It makes up the biggest part of your profit and loss statement, and feeds critical information to your cash flow statement. Don’t worry about that right now, though. We’ll get to that later.
What to include (and exclude) from your expense budget
The most common mistake entrepreneurs make with their expense budget is including some things that don’t belong there.
It would seem logical that all spending should go in the expense budget, but that’s unfortunately not the case. Expenses are deducted from your sales to determine your profitability, but there are other kinds of spending that belong in different parts of your financial forecast. Here are a few things that you need to make sure to keep out of your expense budget:
Direct costs, otherwise knows as “cost of goods” or COGS, belong in your sales forecast, not in your expense budget. Direct costs are essentially what you spend to make your product. Direct costs can be a bit confusing, which is why I wrote a separate guide about that category of spending.
When you buy a car, truck, large piece of equipment, or inventory, you’re spending money, but that spending belongs on the balance sheet and the cash flow statement. The same holds true for other asset purchases, improvements you make to your location, and some startup costs. Smaller equipment such as computers and phones can often be expensed, but you should check with the IRS (or your local tax authority) or consult a tax accountant.
Payments on loans
This one is a bit tricky, but here’s the rule:
The interest you pay on a loan belongs in your expense budget, but the repayment for the principle belongs back on the cash flow statement and will impact your balance sheet.
What you include in your expense budget is nearly everything that’s left over. These are often what are called “operating expenses” and include things like rent, marketing, PR, advertising, and payroll.
How to build your expense budget
Before you start on your expense budget, take a few minutes to think about how you might want to organize it. What is on the list of things that you plan on spending money on? You’ll want to have several categories for your expenses, but you don’t want to have too many categories.
Think about the groups of things that you spend money on and consolidate your list where it makes sense. Also, think about the things that you want to track and keep a close eye on; those things that you want to pay special attention to should have their own categories.
Here are some common expenses to help get you started:
- Interest payments on loans
You can certainly have more categories, and for some businesses this makes a lot of sense. For example, if you have a large marketing budget, perhaps you want to track it in more granular detail.
So, instead of just “marketing,” you might have:
- Trade shows
- Brochures and samples
- Website maintenance
Use a list of expenses that makes sense for your business. If possible, have the list match the categories in your accounting system. If you don’t have an accounting system yet, you can later match your accounting system to your business plan’s expense budget.
Taxes are also considered an expense, so make sure to have that on your list for your expense budget.
How to figure out what the numbers should be
Don’t get hung up thinking that you can’t figure out the numbers that should go in your expense forecast. At the end of the day, you just need to make some educated guesses and then adjust as you learn more about your business.
Start by doing some research. Look at real estate listings to figure out a rough estimate of what your rent might be. Get a quote from an insurance agent to figure out what you might need for your business. Make an estimate about what you might want to spend on marketing.
All it takes is a little research to figure out, roughly, what your expenses are likely to be. Don’t worry about getting it exactly right. You’ll never be 100 percent correct. Instead, focus on “close enough” and then refine and adjust as you grow your business.
Another useful trick is to calculate an expense as a percentage of your sales. This is a common way to calculate some marketing expenses, such as “pay-per-click” advertising. You can estimate that you’ll spend something like 10 percent of every sale on online advertising (or whatever is the right percentage for your industry). Then, as you adjust your sales forecast, your expense budget will automatically adjust appropriately.
Break out payroll into its own list
Because payroll is often one of the largest expenses for a company, it makes sense to calculate that separately from the expense budget and then copy the payroll total into the expense budget.
List out your employees if you don’t have too many, or use categories of people like “customer service” or “sales.” Then input the total salary per month for each person or group on the list.
Don’t forget to pay yourself!
You’ll also want to estimate benefits like health care and payroll taxes as part of your total payroll expense. Use a broad percentage (25 percent is a good guess) to estimate the additional costs of employee benefits. If you want to refine this number, you can research your local and national payroll taxes and figure out more specifically what your other benefits costs might be.
Once you know your total payroll expenses, you can take this number and add it to your overall expense budget.
Track, review, and revise
The goal for setting up an expense budget is to help you make good decisions about your business. Choose your list of expenses that you want to track to align with your strategy and your goals for your business.
To make your expense budget work for you, make sure to set up a monthly review meeting. Usually, doing this a week or two after the end of the month is a good time. Sit down and see how you did compared to your budget. Did you stay on track? Did you go over budget or come in under? Maybe some categories were over and some under.
Also, compare your expenses to what happened the same time last year, or the previous month if you haven’t been in business for a year yet. Check out the trends and adjust course or adjust the budget if necessary.
I use LivePlan for checking on all my numbers because it automates the whole process, but you can also run these reports from your accounting system and use a spreadsheet to see how things are going.
Either way, you’ll probably want to make some changes based on what you find at your monthly review meeting. Perhaps you’ll want to change your expense budget, or maybe you’ll want to get certain expenses under control.
Use the budget to guide your business, and give you the control you need to build a successful business.