By Contessa Rendon, Vice President of Finance — Cyberbacker
Young entrepreneurs can save themselves a load of hassle, as well as a lot of time and money, by avoiding common budgeting mistakes. To budget like a pro, it’s important to take real control of your finances, rather than merely going through the motions. Doing so will set the company up for both immediate and long-term success.
Below, I explain how.
Profit from the beginning
My top recommendation for young entrepreneurs is to stop assuming you can’t make a profit in your first year of business. Many aspiring and new business owners make this mistake, regardless of their age. While it’s true that most small businesses take two to three years to become profitable, this isn’t necessarily the case for all companies, and founders can make decisions that tilt the scale in their favor.
The secret to this is simple: If you budget to make a profit from the beginning, then your business will make a profit from the beginning. This way, founders have the power to schedule profit in starting day one.
This approach is called the “Profit First” model. Essentially, you pay yourself first, reserving portions of your budget for salaries, taxes, and profit. The amount you budget for these items dictates the amount you will have to cover expenses like supplies, shipping costs, rent, electricity, water, and other overhead costs. Profitability is planned for, rather than left up to chance.
Some people question this decision, since it seems backwards. They worry that the business will allocate too much of its budget toward profit, thereby undermining the whole enterprise from the outset.
Granted, if the founders are unrealistic about the amount of profit they can reasonably raise, problems might arise. But in my experience, if the owners build a practical budget, then this won’t happen. Instead, knowing how much they can afford to spend on expenses points them toward the right choices, as they can select options that help them stay within their budget.
For instance, if you want a pricier space but can’t actually afford it and remain solvent for the year, then choosing the less-expensive option would be indicated. You can always move to the more expensive store later, when your business has taken off and the move makes more sense financially.
Through this approach, money can be flexible. People tend to spend however much they have given themselves permission to spend. Expenses will take up as much money as you give them, so make sure you’ve mindfully chosen the amount that will be.
In addition, keep in mind that by assuming you won’t make a profit in your first years, you are basically giving yourself permission to do nothing but spend for a certain amount of time. In my experience, it’s rare for an entrepreneur to stop themselves from spending more and more until that window of time is up, once they have gotten started in that direction. There’s an inertia to that mindset that will consume your company’s profits if left unchecked.
Budgeting is more than deciding
While many young entrepreneurs may believe they’ve created an effective budget by making the initial decisions about where they want their money to go, financial pros define budgeting differently. For us, a budget isn’t really a budget unless it’s effective. For a budget to be effective, it has to have teeth. In other words, the business’s leaders must actually adhere to the dictates of the budget, even when it’s inconvenient or they just plain don’t want to.
Consider the example I gave above. When considering spaces to rent, the amount budgeted for this purpose needs to be binding. The founder shouldn’t choose the pricier option if it will break the budget, no matter how much they love that space.
Similarly, if rent goes up at a business’s existing location, this means the entrepreneur will need to re-evaluate their expenses. Is income such that the price increase can be managed and sustained over the long haul? If so, then maybe it’s okay to stay. Otherwise, it’s time to look into competing spaces and consider a move.
This is just one example. The important point is that entrepreneurs need to commit to their previous budgeting decisions. Without this commitment, their budgeting will be nothing but fantasies on a spreadsheet, and the company will continue to hemorrhage funds. As to where that money goes, it will be hard to say.
Effective companies take control over their finances, which means staying accountable to those numbers on the spreadsheet. It’s not enough to record them once and forget them. Instead, the company needs to build a system for tracking both income and expenditures faithfully. Those in charge of the company’s finances must consult the data on a regular basis.
If the business does break its budget, then it’s important to be honest with yourself. Belt-tightening may be necessary, but don’t worry — all businesses find themselves needing to restrict particular expenses from time to time. Doing so isn’t failure. It’s acting responsibly to protect the company.
Prepare for the unexpected
To launch a company and be successful, entrepreneurs must have a positive vision and a dauntless attitude. No one wants to dwell on negative possibilities, but the truth is that recessions happen.
My final words of advice are to prepare for those inevitable downturns. How? Just acknowledging the existence of these threats is the first step.
Next, I recommend building up buckets of capital for those dry seasons. These reserves will help the company endure through unexpected challenges.
Contingency planning that analyzes the budget for possible savings is also a good idea. That way, the business’s leaders have a head start while troubleshooting. In my experience, it’s also easier to reassess a company’s financial situation with a cool head when the scenario is merely hypothetical. Good decisions are rarely made from fear or while in a panic.
Planning for profit, committing to the plan, and preparing for adversity are the three main ways even a first-time entrepreneur can budget like a pro.
— Contessa Rendon is the Vice President of Finance at Cyberbacker, the leading provider of administrative support and virtual assistant services to anyone in the world from anywhere in the world.