Give yourself some cushion.
6 min read
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When creating a budget for your small business, you are attempting to plan how much money you’ll need to make in order to cover your costs — and then some. But how do you plan when some of your expenses change by the month?
That’s the issue with variable expenses. They are difficult to predict because, as their name suggests, they are rarely the same, even month-to-month. Your best bet is to minimize those costs as much as you can, while arming yourself with the knowledge and tools to prevent them from sinking your business unexpectedly. Understanding variable expenses is the first step to keeping them under control.
What are variable expenses?
Variable expenses, or variable costs, change depending on much you use a product or service. We typically think of variable costs in one of two ways:
- Operating costs: These include utilities, automobile usage expenses like gasoline, office supplies and professional services charged by the hour.
- Cost of goods sold: As your volume of production and output increases, your variable costs also increase since you spend more on raw materials, sales commissions and direct labor costs.
How do variable expenses differ from fixed or discretionary costs?
Variable costs change every day, and thus every month and every year.
Fixed costs, on the other hand, don’t change at all — and if they do, they are unrelated to your production or output. Examples of fixed costs include your rent, insurance payments, any loan payments you might have, subscriptions and annual salaries. You can and should expect fixed costs to remain the same throughout the year, making them easy to budget.
Discretionary costs are a little trickier: These are the “nice-to-have” costs that you dole out when you can afford to spend a little extra on your company, such as through parties and bonuses.
These expenses are variable in the sense that they might cost more or less depending on your discretion, and might be affected by your output. A particularly good month might encourage you to spring for a pizza party on the last Friday. But discretionary expenses could conceivably be zero each month, while variable costs will always appear in some form or another on your balance sheet.
How do variable expenses affect my budget?
In some ways, variable expenses control themselves. Because they are tied to the cost of production, if production slows, your costs also slow. There is little you can do here, which takes planning for it out of your hands.
Overhead variable costs are harder to adjust, and thus harder to plan for. Having a sense of when these costs are going to spike or dip helps. For example, in the summer, electricity bills tend to skyrocket as air conditioners run all day. At the end of the month, you’re stuck with a utility bill that is higher than the month before, throwing your budget out of whack.
How can I protect my budget from these expenses?
Now that we understand how variable costs can confound budgeting, here are seven ways you can get out ahead of them and prevent you from struggling to make the numbers work each month.
1. Strike a deal to pay a fixed amount for utilities.
See if you can talk to your service provider about being charged a fixed amount for your utilities each month, rather than paying a variable rate. You may end up paying slightly more than you would have in the long run, but if your goal is to reduce uncertainty, this is the best way to do it.
2. Invest in tools and practices that lower highly variable costs.
Most electricity providers offer free assessments to see how you can be more efficient in your energy use, but you can also take the time to make sure your HVAC system is running efficiently and that your lights turn off automatically after a certain hour or if they don’t sense motion.
You can also buy tools like smart thermostats that represent a bit of an upfront investment, but eventually pay for themselves by helping keep your costs down.
3. Calculate the variable expense average.
Go back and calculate how much you’ve spent on variable expenses over the past several years. Though some months may be outliers, if you generally pay the same amount each year in costs, you might find that they’re not so variable after all. That said, use the highest average amount over the past three years as your baseline estimate for what you’ll pay this year, just in case.
4. Give yourself some cushion.
Now that you have an estimate — and a high one at that — for how much you think you’ll spend on variables, go ahead and add a cushion of 3 to 5 percent of the total to account for price increases and other anomalies out of your control. Whatever you don’t end up using can go towards your discretionary funds.
5. Always compare your actual spending to your estimates.
At the end of the year, go back and compare what your estimates to what you ended up spending. How off were you? If you were within your cushion, you’ll likely be on track to have a similar result next year; if not, you need to go back to the drawing board and see where you can shift some money over, or even away from your variable costs fund.
6. Create a savings account specifically for variable expenses.
If you budgeted wisely and ended up with a little extra — outside your cushion — at the end of the year, deposit that money in a savings account to help deal with price spikes. Even better, deposit excess funds at the end of each month so you’ll have an emergency fund to dip into if March is colder or September is warmer than expected.
7. Obtain a business line of credit for emergencies.
Sometimes the best-laid plans go awry. Rather than let things fall apart, consider a business line of credit as a backup plan. This revolving form of financing is handy because you don’t need to re-apply once you pay off your first draw, and you only pay interest on what you’ve taken out. LOCs have higher credit limits than credit cards and allow you to withdraw cash, giving you the freedom to pay for major expenses without delay.
Variable expenses are, by their very nature, difficult to plan for. That doesn’t mean you can’t make a plan for dealing with them. If you can cover these by minimizing their impact and dedicating a little more of your budget to them than they might need, you’ll be in good shape.