By Roy Rasmussen
Budgeting is a perennial problem for start-up businesses. 29 percent of start-ups that go out of business fail because they ran out of cash, making this the second-biggest cause of business failure, after not identifying a market need, a CB Insights study found. Pricing and cost issues and lack of funding are other budgeting-related problems that plague startups. Avoiding cash traps means running a lean budget as you’re navigating the pitfalls of the startup phase. Here are four steps to help you get your startup running on a shoestring budget.
Create a Profit-oriented Budget
A profitable business starts with a profit-oriented budget. Whether or not your budget is profitable depends on your profit margins. Profitability is measured by your net profit margin, which is based on taking your total sales, subtracting your total expenses and dividing by your total revenue. For instance, if you generated sales of $500,000 and had total expenses of $250,000, your profit margin would be 50 percent.
Average profit margin varies by industry. Car dealers and gas stations have the lowest average net profit margin at around 2 percent, while oil and gas extraction nets 25 percent, according to Butler Consultants. For most industries, 11 to 12 percent is normal. Service-oriented industries with low overhead costs such as accounting tend to have higher profit margins.
Start-ups in service and manufacturing industries may see higher profit margins of as much as 40 percent until they become large enough to start to have to hire more employees, according to Investopedia contributor Tim Parker. After this, margins will progressively drop as new employees are added. 15 to 20 percent profit margins are ideal for an established service or manufacturing company, but many companies drop below 10 percent.
Given this, you should generally aim for high profit margins in the start-up phase. Investors in the tech industry like to see start-ups with 50 percent profit margins, to give you a high bar to aim for. If your budget doesn’t project profit margins of at least 12 to 15 percent, you probably need to rethink your business plan.
In order to keep profit margins high, you will need to implement strategies to trim your expenses. One key cost-cutting strategy is leveraging technology and automation to lower labor and overhead costs. For instance, using point of sale transaction software that automatically enters data into a cloud-based accounting app can reduce labor costs for data entry. Similarly, using cell phones can save you the cost of investing in a traditional PBX telephone network.
Another way to decrease expenses is to outsource. You can generally outsource functions that are not related to your core business functions, such as accounting, tax preparation and IT. You can also outsource functions where using specialists would increase efficiency and save money. For instance, using a 3-D printing service can cut your production costs.
Automation and outsourcing can also help companies increase efficiency, another key to keeping costs down. Another way to improve efficiency is by streamlining production steps. For instance, 3-D printing can produce objects from a digital blueprint in one step that would normally require several production and assembly steps to produce from a traditional mold.
You can also increase efficiency by replacing email with a more efficient communication app such as Slack. The average American worker spends over half an hour a day on email.
Scale up Slowly
To keep your startup profitable, it’s essential to scale up gradually. Scaling up prematurely is the biggest reason most startups run out of money. Trying to scale up before you establish a market can cause your marketing, labor and production costs to outstrip your profits and cut into your cash flow.
To avoid this problem, test market on a small target audience before you roll out at full scale. As profits come in, reinvest them in financing your gradual expansion. Add staff only as growth justifies it, maintaining your emphasis on automation and outsourcing. As you start to achieve successful expansion, look for ways to increase the efficiency of your marketing and sales process to maximize your revenue.
Roy Rasmussen, coauthor of Publishing for Publicity, is a freelance writer who helps select clients write quality content to reach business and technology audiences. His clients have included Fortune 500 companies and bestselling authors. His most recent projects include books on cloud computing, small business management, sales, business coaching, social media marketing, and career planning.