Being a new small-business owner means you have to figure out a lot of things for the first time. The first of these is how to create a business budget - and that can be intimidating, particularly when you're just starting out. Where and how do you find the right financial information? How do you learn to understand all of the business finance terminologies? And how do you know how to arrange all of that data correctly?
A new business still trying to establish itself may find it difficult to budget correctly and stick to its plan. Nevertheless, it is crucial to start out on the right foot and develop good budgeting practices as soon as possible.
The creation and maintenance of a proper budget will be a critical component of your success if you want to run a successful business. This guide will show you how to create a business budget step-by-step.
What is a business budget?
Budgets are detailed plans that outline how you'll spend your money each month or each year.
Based on what you believe is the best use of your company funds, you assign each dollar a specific function, and then you compare your plan with reality to find out how it worked.
With a budget, you will be able to forecast how much money you expect to earn, plan where to spend it, and identify the gap between your expectations and reality.
When you budget for your business, you make an educated guess about how the financial future of your business will look. Making good financial decisions requires understanding what happened last month, what happened three months ago, and what happened this month last year - and using that information to plan for the months and years ahead.
To run a business you don't need to exactly predict the future, but you do need to know how to create a budget. In order to ensure that everything runs smoothly, you need some intuition.
Why You Need a Business Budget
Creating a business budget is one of those things you can easily overlook while launching your business. Business budgets might not seem important if your company makes significant profits or is experiencing a surge in sales.
In the long run, though, a budget can help your business succeed. When you have a budget, you can see beyond next week and next month, to next year, or even five years in the future.
You can use a business budget to benefit your business by:
- Increasing your business' efficiency
- Finding forgotten funds to invest
- Avoiding debt by anticipating slow months
- Determining when you will become profitable
- Giving insight into the future
- Giving you the power to control the business
Operating your business will be easier and more efficient if you have a budget. In addition to keeping your business out of debt, a business budget can make sure that you're spending your money in the right places and at the right time.
What makes a good business budget?
Simple, flexible budgets work best. When circumstances change, as they will, your budget can flex to show you where you stand at all times.
The 5 Components of a Good Business Budget
Budgets should include these five basic components.
This is how much you anticipate earning from the sale of goods or services. This is all the money you make, regardless of what you invested to get there.
Your budget begins here. You can base your number on last year's figures, or you can look at industry averages.
Fixed and Variable Costs
Your fixed costs are all the regular, consistent expenses that are constant regardless of how much you make - such as rent, insurance, utilities, bank charges, accounting and legal services, and equipment leasing.
Variable costs will vary with your business' production or sales volume and are closely linked with "costs of goods sold," or anything related to the production or purchase of the products your business sells. Raw materials, inventory, production costs, packaging, and shipping are examples of variable costs. Sales commissions, credit card fees, and travel costs can also be variable costs. Your budget should outline how much you expect to spend on all of these expenses.
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Salaries can be classified as both fixed and variable costs. In general, fixed costs are allocated to your in-house team, while variable costs are allocated to freelance employees or one-off project hires. File your different salary costs in the correct section of your budget.
The costs of one-off projects fall outside the normal scope of your business. These are costs such as moving offices, equipment, furniture, and software, along with launch and research costs.
A business's cash flow is the sum of all money coming in and going out. Positive cash flow occurs when your business receives more money than it expends over a certain period of time.
The easiest way to calculate this is to subtract the amount of money available at the beginning and the end of a set period of time.
Cash flow is the lifeblood of every business, so make sure you monitor this weekly, or at least monthly. Despite earning a lot of money, you may not have enough cash on hand to pay for necessities.
Profit is the amount you keep after subtracting all your expenses from your revenue. Growing profits indicate a growing company.
Based on your projected revenue, expenses, and costs of goods sold, you will determine your profit margin. You may need to rethink your cost of goods sold and consider raising prices if the difference between revenue and expenses isn't where you'd like it to be.
Alternatively, you can boost Advertising and Promotions costs in your budget to increase total sales if you think you can't figure in any more profit margin out of your business.
How to Create a Business Budget
Getting started with business budgeting means looking backward at the income and expenses you have already incurred.
Creating your forward-looking budget will be easier the longer you've operated your business since you'll have more data to draw from as you look back on your past performance.
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1. Examine your revenue
In order to create a budget, you need to look backward at your current business and include all of your revenue sources. You can add all those sources of income together to find out how much money comes into your business each month.
Be sure to calculate revenue, not profit, when finding your income. The revenue of your business is all the money coming in before expenses are deducted. Profit is what remains after expenses are subtracted.
After you have identified all of your income streams, calculate your monthly income. Ideally, you should do this for at least the past 12 months, if you have that much data available. By looking at 12 months, or more, of information, you can see how your monthly income changes over time and identify seasonal patterns.
2. Subtract your fixed costs
Your second step in preparing a budget for your business is to add up all fixed costs. You can think of fixed costs as any costs you incur on a recurring basis to operate your business. Make sure you get as much data as you can about fixed costs, since they can happen daily, weekly, monthly, or even yearly.
Your business may incur the following fixed costs:
It's likely that your small business will have different fixed costs than what's described here. Consider if your business has any other fixed costs. After you've identified your business's fixed costs, subtract them from your income before moving on to the next step.
3. Determine your variable expenses
While searching for the information you need to set up a list of your fixed costs, you might have also come across some variable expenses within your business.
A variable expense is one that changes based on how much you use the service. The majority of these are necessary to operate your business, such as utilities.
Expenses that are not necessary for the operation of your business, but would be nice to have, like education, or costs that can increase profitability, can be found here as well. These are discretionary expenses, which can also be included in your variable expenses fund.
Variable expenses include:
- Owner’s salary
- Office supplies
- Marketing costs
Your business will need to reduce its variable expenses during low-profit months, beginning with discretionary spending. In profitable months, however, you can increase your spending on variable expenses for the long-term benefit of your company.
4. Create your profit and loss statement
In order to create your profit and loss statement, or P&L, you need to gather all the information listed above.
Even talking about a P&L can be nerve-wracking for some. Nevertheless, you've already done the hard work. You'll need to add up all your income and expenses for the month and subtract them from each other. Then, deduct the expenses from the income to arrive at a number.
If your number is positive, you’ve made a profit, If not, that’s a loss — and that’s okay. Small businesses don’t make money month after month, let alone year after year. This is especially true when your company is just getting started.
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5. Outline your final budget
Whether you're a brand new business or a seasoned veteran, predicting the future of your business requires educated guesswork. However, you'll be better able to make accurate predictions if you have experience in business.
You have now completed your P&L, a document that illustrates the past of your business. It is now time to make your budget. Budgets are forward-looking and future-oriented.
Budgeting Tips for Small Business Owners
All business owners want to make money, but no one wants to be concerned with cash flow and money every day of their lives.
Building and growing your business requires money, and success means you keep earning back your investment and more in profits. To keep your finances in order, you should not constantly think about your money and check your account balances every day.
Budgeting is crucial for this reason. You must be clear about how much and on what you will spend your money. Keeping track of where all that money will come from is also essential.
Overestimate your Expenses
¨Trying to predict revenue and expenses accurately is one of the biggest challenges in any budget. After all, you never know what the future holds. In the end, no budget forecast can ever be precise to every last detail.
You need to be ready for the budget to go wrong, however. Embrace a larger margin of error by overestimating your expenses. Don't be afraid to leave yourself some extra room so you'll be prepared if things don't quite go as planned.
Schedule Regular Budget Check-ups
Budgets are only as useful as you make them. A detailed, comprehensive budget you put together, but you never look at it again, isn't going to do you any good. Regularly review your budget at consistent intervals throughout the year.
Accounting for a small business is all about staying on top of your finances and staying in control. As you review your budget periodically, assess how your actual expenses and spending compare to your forecast. You'll then be well-informed and ready to make the best business decisions.
There will be times when you have to exceed your budget. Occasionally, circumstances force you to do so. However, you must make a conscious decision when deviating from your budget.
Consult with a Professional When in Doubt
If you are unsure about how to make a budget that reflects these concerns, don't hesitate to ask for some help. Working with an accountant will help you create your first budget and establish good budgeting and bookkeeping practices to support your growing business.
Accounting professionals can give you an objective viewpoint to help you predict revenue and expenses, as well as all the expertise you need to develop a comprehensive budget. An accountant can also be enormously helpful to a small business when calculating taxes later on.
Starting a new business is risky. There is a lot at stake. Make sure you are ready to manage the risks and reap the rewards by working with a professional.
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