How to Create a Budget

It's not glamorous, but a budget will help manage costs, identify red flags, and achieve profitability

Apex Facility Resources: McCauley and Watson "just threw people at growth," hiring sales staff rather than looking at the bottom line Brian Smale

By Amy S. Choi

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Between 2004 and 2007, Apex facility resources, a Seattle furniture dealership and relocation company, experienced a 900% jump in sales. Yet the owners, Marlaine McCauley and Matt Watson, didn't know if they'd actually made any money. "We didn't have any kind of operating budget when we started growing," says McCauley. "We just threw people at growth," hiring more and more salespeople rather than looking at the bottom line. "We tried to invest in some accounting systems, but it didn't work. We didn't really know where we were as a business."

Like McCauley and Watson, plenty of entrepreneurs prefer to focus on boosting the top line rather than wade into the nitty-gritty of financial management. "I ask my clients how much money they make, and the answer is always, 'I don't know, it depends on how the business does,'" says Heather Hutchinson, principal at Hutchinson & Ziegler Financial Advisors in San Rafael, Calif. "Entrepreneurs often start their business and run it without a clear idea of what they are going to get out of it."

For Apex, the failure of that strategy became abundantly clear last year: The 61-employee business hit a high of $10 million in revenues, but "we didn't have anything on the net side," says Watson. The company wasn't broke, but it wasn't turning a profit, either.

Creating a budget is not glamorous. But a budget can help you gauge profitability, manage costs, and easily spot red flags. And it's especially prudent to know your numbers inside and out in today's economic environment. "During a 'regular' business cycle, you can count on certain revenues and customers and pricing," says Larry Cox, associate professor of entrepreneurship at Pepperdine University. "Of course, we don't live in that kind of world anymore. You can't predict a big bank bankruptcy."

In some cases, a comprehensive budget may help reshape your company entirely. Brian Milburn, owner of Milburn Group Interior Design, a $1 million, three-employee San Diego firm that recently moved to a tightly managed budget after using a more laissez-faire operating system, says the switch has permanently changed his company: "Business is going to be different for us. We have found a very lean comfort zone, and our overhead is low and our value high to the client. We won't go back."

The best-laid plans, of course, can fall apart. Even if you think you've got your budget figured out, it's critical to be flexible and even have a secondary budget to fall back on.

To get a better grip on your numbers, you first need to figure out what your company is trying to achieve financially. Then evaluate every dollar that goes in or out. Once you have a thorough understanding of expenses and income, you'll be able to create a base budget you can use to predict and guide your year ahead.

Although it may seem obvious, you need to go beyond setting goals: You need to quantify them before you can set a budget that will help you get there. Is your aim to hit $1 million in sales? Or to achieve a 20% margin? Or to take home a salary of $200,000 a year?

Starting from the bottom line, or even a personal financial target, rather than a sales goal, can be motivational for a business owner. But sometimes the object can be as simple as not losing money. Last year "was an eye-opener because we had such a good top line, but we had so much fat and were misreporting and inaccurately managing our costs and revenues," says Watson, who is vice-president for business development at Apex. "So our initial goal for 2009 was to break even, which meant we had to sell $600,000 a month."

BUILD A HISTORY

A detailed understanding of your expenses and sales is the cornerstone of any effective budget. Pull your financials going back at least two years and pay special attention to seasonal fluctuations. What are your biggest sales months? When are the downtimes? When do your costs spike? What percentage increases have you seen in specific costs and sales?

Don't look at the numbers in a vacuum. "Make it a group effort," says Lisa Coston, senior audit manager at Daniells Phillips Vaughan & Bock in Bakersfield, Calif. "

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