The different acronyms and financial models in budgeting can intimidate some business owners. But it shouldn’t be that way. There are only three tools you need to be familiar with to understand budgeting.
Because budgeting can be intimidating, entrepreneurs may spend less time on financial planning and more on their product and ideas. But, not knowing the basics of budgeting can be damaging to a new business and quite possibly be the cause of its failure before the end of the first year.
Budgeting is important for three reasons: It helps
1. pay the bills 2. measure your financial health 3. make money
If people are paying for your product and you are generating revenue, that’s the sign of a good idea at the heart of your startup. Don’t let bad financial planning be the reason why your great idea doesn’t succeed.
Understand and use 3 of the most important and basic tools for budgeting to get your finances in order.
1. Income statement
An income statement measures the financial performance of a business over a period of time – a quarter, month or year. The first thing you’ll see on top of an income statement is revenue which is money brought in by business activities. That is followed by “cost of sales” – the amount of money to manufacture the product including materials, labor, and factory overhead.
The gross margin is then calculated through the difference between revenue and cost of goods sold. That is a key indicator of whether or not you are making money. Further expenses, income and taxes are then accounted for. At the bottom of the income statement, net income is calculated which is total profit made by the company over the time period.
2. Cash flow forecast
Cash is king to most people. They determine their financial status by how much cash they have. Business owners with that perspective operate better knowing how much cash they have, and where it’s going. But they can’t gauge their cash flow from an income statement. That’s where cash flow forecasts come in.
They help predict cash shortages or excesses which can facilitate business decisions. Being able to estimate the future financial impact of a decision can help entrepreneurs tremendously. For example, deciding to hire a new full-time employee this month, your cash flow forecast can reveal whether or not you’ll lose or save money from this decision within the fiscal year.
Forecasts normally cover a year, but some short-term ones cover a week or month.
3. Balance sheet budgeting
Balance sheets group together the total values of a company’s assets, liabilities and shareholders’ equity at a specific point in time. It is usually made at the end of a financial quarter, month or year. Balance sheets provide an indicator of the financial health of the company and are especially useful to investors and shareholders.
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