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7 Important Tips to Follow When Creating a Budget (and Avoiding Pitfalls)

This article originally appeared on Inc.com as part of BusinessBlocks CEO Justin Kulla's weekly Inc. Magazine column. To see the original post, click here.

For many businesses, budget is a dreaded word. For small businesses, sometimes it's entirely foreign. As a small business owner you have many hats to wear and budgeting doesn't make the top 50 list. Even if you believe it is a good thing to do, it is the business equivalent of going to the gym after the big Thanksgiving meal: "a smart thing to do, but maybe it can wait for tomorrow".

But it is the time of the year to start planning for next year. OK, so now that we know budgeting is full of excuses, how do you get started?

1. Just Get Started

It's that simple. Set aside some time and hold yourself to it. I like to actually add it to my calendar and treat it like an official appointment. It's not easy but starting is really the hardest part.

Either start with a blank sheet of paper if you are a new business or use your past years' finances to create a benchmark. You'll be able to see your revenue, gross profit and cash flow. You might not like some of the numbers but it'll help you understand how to change your business in the coming year. Do you want to grow revenue? Or maybe, you'd prefer to focus on more cash flow? The budget will help you plan 2018. "It's like a roadmap for your company" says Victor Butcher of Butcher Financial Services.

2. Make A Working Budget

Create a personalized sheet that you feel comfortable using weekly. That way budgeting isn't a one time event but just a part of your regular routine. Trust me, it's much easier if you create a weekly block of time to manage your budget. 

If you have a weekly or even monthly budget, you can track your performance over the year and make strategic and operational changes as you see your numbers exceed or miss estimates. If you can, formalize the budget by using an automated template and keep a running copy for review and comparison. Your accounting program may offer one or develop one with the aid of your accountant.  

3. Spend Realistically

If you are a novice business try to assemble as much data as possible for your industry and regional area.

  • Realize that startup costs may be higher than you expected. Don't commit to large ticket expenses until you are sure that you have the required startup capital. Scrutinize lease commitments and large equipment purchases. Include all purchases even office supplies. Determine your fixed expenses such as rent, insurance, business fees. These are not contingent on sales so be conservative.

  • Variable expenses such as production, shipping, labor and marketing are contingent on your sales. When estimating your sales, include seasonal spikes and troughs. Make sure you allocate enough cash flow for increased inventory levels at certain calendar periods.  A good rule of thumb is to increase expense estimates by 10 percent and decrease sales projections by 20 percent.

  • Leave wiggle room. Make an allocation for an unexpected or increased expense. Be tough on "what you need" as opposed to "what you want". Don't splurge until you are sure that you have coverage for emergencies. I know, I know, easier said than done.

  • If you are a business with a track record, don't get lulled into thinking every budget year is the same.  Don't let an overly optimistic cash flow projection cause a budget crunch. Anticipate for the possibility of slower sales and make sure you have a cushion.

4. Hope for the Best Plan for the Worst

Just like your parents probably told you, be prepared. As a small business owner you want to be optimistic but you must also plan for risk and unexpected adverse situations. 

  • Don't count on certain sales from a new marketing campaign or new product launch.

  • An unexpected delay in product delivery could create a late payable.

  • Anticipate economic downturns or slowdowns.

  • A brand new business needs some "runway" to become profitable.  

5. Don't Spend All the Profit

It is essential to set aside a percentage of the profit for a contingency fund. This is very important in the early stages of a small business when you are operating without a track record for budgeting. A reserve fund will alleviate the pain of getting caught in an unexpected cash crunch. All businesses will benefit from creating and maintaining a dedicated contingency fund. Make sure that you keep this fund strictly for those times when you are facing a real cash crunch. The peace of mind is well worth the expense.

Shave your own salary if you must to create it.   

7. Don't Forget Taxes

Discuss this with your accountant. Remember that you must allocate for sales taxes and taxes on any net profit. "Escrow" a small percentage of each sale to provide some coverage- ask your accountant for a reasonable percentage based on your area and particular business situation.

8. Revise and Revise

The budget will be an invaluable tool to analyze your actual cash flow versus your projections and to allow for adjustments. A regular review of the budget will highlight any discrepancies between your projected sales and actual sales. It can also be a flag to correct any potential cash flow problem before it becomes too damaging. Every new small business owner should review their budget weekly and perhaps review it monthly with their accountant in the first year. Creating and maintaining the budget will give you a sense of empowerment in running your business and increase your chance of success.