Capital Budgeting

Capital Budgeting

For many small-business owners, the process of budgeting is limited to making arrangements to get the cash for regular business payments like wages and utility bills. Small business owners often find it hard to spend time to do any short or long-range financial planning as they are caught up with day-to-day activities. But failing to plan financially might mean that you are unknowingly planning to fail.

Business budgeting is one of the most powerful financial tools available to any small-business owner. Maintaining a good short and long-range financial plan enables you to control your cash flow. The most effective financial budget includes both a short-range month-to-month plan for at least a calendar year and a quarter-to-quarter long-range plan you use for financial statement reporting.

The long-range plan should cover a period of at least three years (some go up to five years) on a quarterly basis, or even an annual basis. The long-term budget should be updated when the short-range plan is prepared.

 

What Do You Budget?

Many financial budgets provide a plan only for the income statement; however, it is important to budget both the income statement and balance sheet. This enables you to consider potential cash flow needs for your entire operation, not just as they pertain to income and expenses. For instance, if you had already been in business for a couple of years and were adding a new product line, you would need to consider the impact of inventory purchases on cash flow.

Budgeting the income statement only also doesn't allow a full analysis of potential capital expenditures on your financial picture. For instance, if you are planning to purchase real estate for your operation, you need to budget the effect the debt service will have on cash flow. In the future, a budget can also help you determine the potential effects of expanding your facilities and the resulting higher rent payments or debt service.
 

 

How Do You Budget?

In the start-up phase, you will have to make reasonable assumptions about your business in establishing your budget. You will need to ask several questions on various aspects of business such as:

  • How much can be sold in year one? 
  • How much will sales grow in the following years? 
  • How will the products and/or services you are selling be priced? 
  • How much will it cost to produce your product? How much inventory will you need? 
  • What will your operating expenses be? 
  • How many employees will you need? How much will you pay them? How much will you pay yourself? What benefits will you offer? What will your payroll taxes be? 
  • What will the income tax rate be?  
  • What will your facilities needs be? How much will it cost you in rent or debt service for these facilities? 
  • What equipment will be needed to start the business? How much will it cost? Will there be additional equipment needs in subsequent years? 
  • What payment terms will you offer customers if you will sell on credit? What payment terms will your suppliers give you? 
  • How much will you need to borrow? What will the collateral be? What will the interest rate be?

 

Source:
  1. Excerpted from Start Your Own Business: “The Only Start-Up Book You'll Ever Need”, by Rieva Lesonsky and Entrepreneur Magazine
  2. SCORE