Budgets and planning is the core of financial management. Let this become one of your strongest and most valuable skills as an entrepreneur.
Budget Terms
What are operating expenses?
Although different businesses have different costs associated with them, the main operating expenses of most businesses include:
- Rent. Under many lease agreements, you’ll be expected to provide the first month’s rent plus a security deposit. Many lessors also require the last month’s rent.
- Phone and utilities.
- Equipment. Equipment costs vary from one business to another. At a minimum, most businesses need office equipment, signage and security systems. To determine your costs, list all the equipment you must have to efficiently operate your business.
- Fixtures. This broad category includes partitions, panelling, signage, storage cabinets, lighting, check-out counters, and all shelves, table stands, wall systems, showcases and related hardware for product display. The cost of fixtures depends on your business location, the size and condition of your facility, the type of business you’re in, what kind of image you want it to project, and whether you’re purchasing new or used fixtures.
- Inventory. Like equipment, inventory requirements vary from business to business. Some businesses, such as retail stores, are inventory-intensive, whereas others, such as personal shopping services, don’t require any inventory at all except office supplies.
- Leasehold improvements. These non-removable installations, either original or the result of remodelling, include carpeting and other floorings, insulation, electrical wiring and plumbing, bathrooms, lighting, wall partitions, windows, ceiling tiles, sprinkler systems, security systems, some elements of interior design and sometimes heating and/or air-conditioning systems. Because the cost of improvements can vary tremendously, get several estimates from reputable contractors.
- Licences and tax deposits. Most cities require business operators to obtain various licences or permits to show compliance with local regulations. Licensing costs vary from business to business, depending on the requirements of your particular location.
- Marketing budgets. Most companies determine their first year’s advertising budget as a percentage of projected gross sales, typically two to five percent.
- Professional services. Generally, this refers to your lawyer and accountant. Their fees will range according to their expertise, and the location and size of their practices.
- Payroll. Salaries and fees paid to full time and part time employees, directors and/or consultants.
- Insurance. A word of caution when estimating these costs: if there’s ever a time to be conservative, it’s now. Err on the high side when you project expenses and on the low side when you project revenue. And don’t forget to add a “rainy day” or contingency fund to cover the costs of unforeseen expenses – somewhere around five percent of your budget is a typical amount to set aside. This financial cushion will help you and your investors to avoid panic in case you’re faced with an expense you hadn’t budgeted for
What does the term Overheads refer to?
Overhead refers to all non-labour expenses required to operate your business. These expenses are either fixed or variable:
1. Fixed expenses
No matter what your sales volume is, fixed costs must be met every month. Fixed expenses include rent or mortgage payments, depreciation on fixed assets (such as cars and office equipment), salaries and associated payroll costs, liability and other insurance, utilities, membership dues and subscriptions (which can sometimes be affected by sales volume), and legal and accounting costs. These expenses don’t change, regardless of whether a company’s revenue goes up or down.
2. Variable expenses
Most so-called variable expenses are really semi-variable expenses that fluctuate from month to month in relation to sales and other factors, such as promotional efforts, change of season, and variations in the prices of supplies and services. Fitting into this category are expenses for telephone, office supplies (the more business, the greater the use of these items), printing, packaging, mailing, advertising and promotion. When estimating variable expenses, use an average figure based on an estimate of the yearly total.
Capital Requirements
How to determine how much capital is needed for a start-up?
To determine how much you’ll need for start-up, account for all opening expenses along with your initial operating expenses. Although different businesses have different costs associated with them, the main start-up costs include these:
- Rent. Under many lease agreements, you’ll be expected to provide the first month’s rent plus a security deposit. Many lessors also require the last month’s rent.
- Phone and utilities. Some telephone and utility companies require deposits, while others do not. A deposit may not be required if you own real estate or have a previously established payment record with the company. Telephone deposits are determined by the number of phones and the type of service required. Unless you need a large number of phones and lines, the deposit won’t be too costly. Deposits for petrol and electricity (when required) will vary according to your projected usage, so get accurate information and carefully project your numbers.
- Equipment. Equipment costs vary from one business to another. At a minimum, most businesses need office equipment, signage and security systems. To determine your costs, list all the equipment you must have to efficiently operate your business. Next, price those items by obtaining quotes or bids from at least three vendors. Use the quotes you receive to estimate your start-up equipment costs.
- Fixtures. This broad category includes partitions, panelling, signage, storage cabinets, lighting, check-out counters, and all shelves, table stands, wall systems, showcases and related hardware for product display. The cost of fixtures depends on your business location, the size and condition of your facility, the type of business you’re in, what kind of image you want it to project, and whether you’re purchasing new or used fixtures.
- Inventory. Like equipment, inventory requirements vary from business to business. Some businesses, such as retail stores, are inventory intensive, whereas others, such as personal shopping services, don’t require any inventory at all except office supplies.
- Leasehold improvements. These non-removable installations, either original or the result of remodelling, include carpeting and other floorings, insulation, electrical wiring and plumbing, bathrooms, lighting, wall partitions, windows, ceiling tiles, sprinkler systems, security systems, some elements of interior design, and sometimes heating and/or air-conditioning systems. Because the cost of improvements can vary tremendously, get several estimates from reputable contractors.
- Licences and tax deposits. Most cities require business operators to obtain various licences or permits to show compliance with local regulations. Licensing costs vary from business to business, depending on the requirements of your particular location. In addition to these fees, you’ll also need start-up capital for tax deposits if yours is a retail business. Many states require a deposit against future taxes to be collected.
- Marketing budgets. Most companies determine their first year’s advertising budget as a percentage of projected gross sales, typically two to five percent.
- Professional services. Before you officially open your business, get help from a knowledgeable lawyer and accountant who work with small business owners to make sure you meet your legal and tax obligations. Their fees will range according to their expertise, and the location and size of their practices.
- Pre-opening payroll. If your business is going to be a full-time venture, set aside a salary for yourself in addition to a three-month reserve, just to play it safe. This rule of thumb also applies to any employees you might hire during this phase of business start-up.
How conservative should a business person be when estimating my start-up capital requirements?
If there’s ever a time to be conservative, it’s now. Err on the high side when you project expenses and on the low side when you project revenue. And don’t forget to add a “rainy day” or contingency fund to cover the costs of unforeseen expenses – somewhere around five percent of your budget is a typical amount to set aside. This financial cushion will help you and your investors avoid panic in case you’re faced with an expense you hadn’t budgeted for.
What is undercapitalisation?
Undercapitalisation is the condition that exists when a company doesn’t have enough cash to carry on its business and pay its creditors.
When you’re launching a business or starting out as the new owner of an existing business, proper planning and research are absolutely necessary. Undercapitalisation can be a major problem, one that may lead you right out of business.You don’t necessarily need piles of money to start a business.
Apple Computer was started in a garage by Steve Wozniak and Steven Jobs. Yahoo! was founded by a pair of Stanford University graduate students, Jerry Yang and David Filo, to help their fellow students locate cool websites. There is nothing wrong with this approach if you’re willing to invest a great amount of time and energy into making the business work. But keep in mind that undercapitalisation is the number one killer of start-up businesses. Don’t skimp on getting enough money to start your business right.
What is required when asked to substantiate and motivate sales projections?
The heart of any new business concept is the monthly sales forecast. Sales usually climb more slowly than business owners expect, and the expenses pile up faster. For start-up companies, the initial business plan should include a month-by-month projection for the first year, followed by annual projections going out a minimum of three years.
All projections should be broken down into months, especially when it comes to the first year. To prepare the sales projections you have to do a great deal of thorough research. Remember sales forecasting takes into account the economic climate, current sales trends, and capacity for production, company policy and market research.
You have to collect this information by doing research and then analysing it in a way that makes it possible to estimate what your sales will be. Do extensive research to establish the total number of potential customers that you believe that the company can realistically count on. There are many sources of information to assist with your sales forecast. Some key suggestions are:
- Competitors
- Trade suppliers
- Chambers of Commerce and business associations
- Trade publications
- Networking groups
Determine current trends by talking to suppliers about what is selling well and what is not. Get out on the street and study your competitors. Visit shops, business, websites and locations where their product is offered. Analyse the location, customer volumes, traffic patterns, hours of operation, busy periods, prices, quality of their goods and services, product lines carried, promotional techniques etc.
In any sales projection, you will have to make some basic assumptions about the customers in your target market.
Experienced business people will tell you that a good rule of thumb is that 20% of customers account for 80% of sales. Use this research to estimate your sales on a monthly basis for your first year.
There are various types of financial projections that you will need. The first is a month-by-month projection for the first year.
First Year:
This is the main planning and monitoring vehicle and the forecast must be updated monthly. The initial capital costs depend on the kind of business you are starting. These costs could include décor, lighting, equipment, tools, office furniture, telephones and internet installation. Other costs include registering the business, drawing up of agreements (legal fees), stationery such as business cards, a logo, web site design and maintenance.
Long-range plan
The long-term forecast must show the strategic plans for the business. Start-ups have to plan for various ongoing costs such as rent and salaries and the cost of having staff on site. If you run the business with a sales team, work out the number of calls each one can make, the number of calls and average length of time expected to close a sale, average close rate per sales person.
The incentive structure will also have an impact on the projected forecast depending on how the staff is rewarded. You will also have to include production costs, tax, telephone, electricity, water, insurance and if you have taken a loan to fund the start-up, you must include the interest on your loan.
Cash Forecast
The purpose of the cash forecast is to break down the budget ever further. Don’t forget that the focus must be on cash flow rather than accounting profit. A cash flow projection shows the amounts of money your business expects to receive and pay out each month in a rolling six- or 12-month period. This forecast takes into account the lag time between billing your clients and getting paid; incurring an expense and paying for it; and paying tax. Don’t forget to consider any seasonality associated with buyer behavior.