Budget surpluses can be very positive since you can save, spend, or reinvest that extra money back into your business.
But there’s more to surplus budgeting than simply having extra cash. As a business owner, you should also become familiar with how budget surpluses work and how to calculate whether or not your business can sustain one. Here’s what you need to know.
The ins an outs of a budget surplus
A surplus occurs when you have more than what you need. However, the business budget surplus definition is a little different.
When you’re talking about businesses, a surplus occurs when your revenues exceed your expenditures. Business budget surpluses are also known as free cash flow or profits. So, as long as an organization spends less than its budget permits in a specific fiscal period, there’s a surplus.
To be clear, surpluses aren’t a budgeting methodology, but, rather, an event that occurs when a business retains more money than it spends. If the opposite should occur – which is to say, if you spend more than you save, there are no profits, but, rather, a deficit in the budget.
While a budget deficit is not a situation you want to find yourself in, a flexible budget with a surplus could benefit your business because it means you have additional resources to reinvest.
Example of a surplus in budget
Although your accountants and expense software will do the math for you, it helps to know what your projected budget might look like at the end of your fiscal period. The good news is that finding your budget surplus involves a simple equation:
It’s worth noting that the final figure from your formula only counts as a “surplus” if it’s a positive number. A negative figure denotes expenditures, which means that you’re running a deficit, not a surplus.
Here’s how the formula works:
A new business expects to bring in $200,000 in revenue for the following fiscal year. However, they anticipated spending $194,000 on fixed expenses, like salary, benefits, rental space, and equipment costs. Using the equation above, you can see that the business has an expected budget surplus of $6,000.
$200,000 – $194,000 = $6,000
If the business ends up spending more than the projected profit figure of $6,000, then it would end up with a deficit. However, the projected $6,000 surplus is the business’s own to invest in new opportunities or put the sum back into the business by upgrading equipment or paying for employee training.
Debt-to-equity ratio: Total liabilities / total shareholders’ equity
i.e. $180,000 / $75,000 = 2.4 D/E ratio
Let’s break it down. Debt comes from taking out loans that have to be paid back no matter what, so even if your business performs poorly you will still owe the same amount. This is why debt has greater risk.
Equity works differently—it allows investors, such as venture capitalists or shareholders, to own part of a company. This means as the value of the company grows, so does the equity, and as the value of a company decreases, the equity goes down with it.
Your company’s industry and size will help determine the capital structure that’s right for you. Industries with unpredictable cash flow are usually not a good fit for debt-based financing. Smaller companies may struggle to grow without a high amount of debt.
Other types of fiscal surplus
A budgeting surplus is not the only type of surplus a business may experience.
An inventory surplus occurs when a business has more inventory than is necessary for its projected sales period. This kind of situation instantly puts business owners in mind of untouched, shelved products with little to no demand.
The fact is that an inventory surplus can be an asset or a liability. It can be costly to hold inventory surpluses, especially if the items in the inventory have an expiration date or must be used before a given date. This can make it a liability.
However, if your products are evergreen, you’ll be able to fulfill orders more quickly and replenish your proverbial shelves with a faster response time. And, if there’s ever a shift in demand, your surplus will be on hand to help you capitalize on the situation.
If this happens, it may be time to rethink your pricing strategy. Another solution is to find a new way to market your products to make them more appealing.
Consumer surpluses occur when the cost of a product or service is lower than the amount consumers would willingly spend. For example, a customer might buy an item for less than they were willing to pay, which benefits the customer, but also means that your business needs to keep informed of where the ceiling on price lands. Doing so is the only way to stay competitive.
Keep in mind that a consumer surplus is a macroeconomic concept, and it increases when the price of a good falls.
Another macroeconomic or “market-focused” surplus is a producer surplus. This is the difference between how much a producer would be willing to accept for a given quantity of a good versus how much they can receive by selling the good at the market price.
Here’s how it works:
- Let’s say it takes a phone case manufacturer a total of $4 in costs to make a phone case. They can’t sell it at cost, exactly, as they do have a profit margin baked into the unit price of the good.
- In this case, let’s make that at least $2 they’d like to earn on each sale.
- However, the market price for this type of good averages around $20.
- So the difference between what they’d be willing to accept – $6 – and the market price of $20 gives them a producer surplus of $14.
The $14 cushion gives the producer a lot of wiggle room when they’re ready to create a sale. They can “slash prices” while still making a profit or surplus, as long as they don’t pass the $6 acceptable mark.
What to do with a budget surplus
If you find yourself with a surplus, you have two main options: You can either save it or spend it. Here are some potential opportunities with both.
Option #1: Save your surplus
Saving your surplus could mean putting that money in a savings account, which a business owner could use for emergencies or unexpected cost increases. Another option is to invest it to try and increase your resources over time.
Option #2: Spend your surplus
You may decide to spend your surplus on debt, or reinvest in your own business, whether that’s increasing your investment in marketing initiatives or hiring a new employee.
Balancing your surplus with ease
Having a budget surplus means you have leftover money that you can save or spend. Knowing how much budget surplus you’ll have in a set period enables you to make smart financial decisions that align with business goals.