A Start-up Budget is a Guess.
Budgets are pro forma documents. The term pro forma in the accounting sense means that you are guessing. In a new business, you have no way of knowing how much your customers will buy nor what your real expenses will be. So you have to guess. That's all it is. There is no magic way to tell if your guess will come true.
Your Purpose is to Convince Your Lender.
You don't have to guess right, you just have to convince a lender that you know what you are talking about and that you have a chance of making your guess come true. If a lender believes you, you get the loan. Small business start-ups are the most risky loans a bank can give, and the lender wants to minimize the risk.
Focus on Cash Flow, not Profits.
Cash flow and profits are not the same thing. Many start-up businesses can show a profit at the end of the year, but they may not have enough cash each month to pay employees or creditors. Pay attention to your cash balance at the end of each month, so you know whether you will need money to pay bills.
Create Three Different Budget Scenarios.
- First, create a wildly optimistic scenario. Imagine the best possible income situation and figure a minimum of expenses.
- Second, create a "worst case" scenario budget. Figure no one will buy your products or use your services for the first six months. And double all your expenses during that time. How awful does your cash flow look?
- Finally, create an expected budget that is somewhere in between, neither too optimistic nor too pessimistic. This is the one you show the bank.
Over-estimate Expenses and Under-estimate Income.
Small business owners are optimistic. But, there is a time to be optimistic and a time NOT to be optimistic. When you are creating your financial projections for the business you want to start, when you are setting up your business budget, or when you are taking a business expansion project to the bank, you can't be too optimistic. You must be pessimistic when it comes to income and expenses. Lenders look skeptically on budgets that are overly optimistic; keeping yours more reasonable will help convince your lender that you are capable of managing your finances. It will also help you avoid the problem of not ending up asking for enough working capital to keep you going when your cash flow doesn't meet those over-optimistic expectations.
Budgets are Moving Targets.
Your initial budget will change many times as you find a location, buy equipment and supplies, and begin making arrangements for monthly costs. Stay flexible and keep updating your budget and showing it to your lender. You will also need to keep revising income estimates, particularly during the first year. At least monthly, you should review your estimates and compare them to the actual. Your lender will want to see your budget at least quarterly, to see if you are on track.
Providing your lender complete, accurate, and reasonable figures in your projected budget will help you sell your business plan to your lender and obtain the financing you need for start-up and operations.
