When you started a small business, did you dream of how to create a budget?
What about writing up a business plan or balancing the books, reconciling your balance sheets, and pouring over profit and loss statements? Likely not! Most entrepreneurs are impassioned about an idea or long for the freedom of being their own boss. But, like it or not, budgeting is critical to any efficient, effective organization. Why is it so important – and how do you learn to prepare a sensible budget?
What is a business budget?
A business budget is a detailed financial plan that outlines where a company intends to spend its resources over a specified period, usually a fiscal year or quarter. It serves as both a forecast and a roadmap for the organization’s financial activities, helping business owners and managers allocate resources, gauge the company’s financial health, and make informed decisions.
What Does a Small Business Budget Entail?
Here’s a deeper dive into what a business budget entails:
- Revenues: This is the starting point for most budgets and refers to the total amount of money the company expects to bring in during the period. This can include sales, investment income, or any other sources of revenue.
- Fixed Costs are regular, predictable expenses that don’t change regardless of how much or how little a business produces or sells. Examples include rent, salaries, and insurance.
- Variable Costs: These costs fluctuate based on your business’s activity levels. For instance, if a company produces more goods, its raw material costs and possibly labour costs will increase. Examples include raw materials, direct labour, and sales commissions.
- One-time Expenses: These are unique or unexpected costs that are not regular business expenses. Examples might include purchasing a new piece of equipment or fees associated with moving to a new location.
- Cash Flow: This component assesses how cash moves in and out of the business. Businesses must ensure that they have enough liquidity to cover their immediate expenses.
- Profit & Loss (P&L) Forecast: This overviews the expected income and expenses over the budget period, helping businesses anticipate profits or losses.
Benefits of a Business Budget:
- Financial Control: A budget helps businesses keep their spending in check and remain within predefined limits.
- Resource Allocation: Businesses can prioritize their expenditures and allocate resources more efficiently by knowing their expected income and costs.
- Performance Measurement: Comparing actual results to budgeted figures can help identify areas where the business is underperforming or outperforming its expectations.
- Informed Decision-making: With a clear understanding of their financial situation, businesses can make well-informed operational and strategic decisions.
- Forecast Challenges: By forecasting expenses and revenues, businesses can anticipate potential cash shortfalls or other challenges and plan accordingly.
- Goal Setting: Budgets translate the company’s strategic goals into financial terms, offering a roadmap for what the company hopes to achieve in a fiscal period.
How to create a business budget in 13 Steps
1. Determine Your Time Frame
Decide whether you’re creating a monthly, quarterly, or annual budget. The duration will depend on your business’s needs and your desired level of detail and accuracy.
2. Gather Historical Data
Review past financial statements, sales records, expense reports, and other relevant financial data. This will provide insight into your business’s historical revenue and expenditure patterns.
3. Estimate Revenues
Based on your historical data and future projections, estimate how much revenue you expect to earn during the budget period. If you’re a startup or a newer business without much historical data, you might need to rely more on industry benchmarks and market research.
4. List Fixed Costs
Identify all regular, consistent expenses your business incurs, such as rent or mortgage, salaries, utilities, and insurance. These tend to remain stable regardless of business operations.
5. Identify Variable Costs
Estimate expenses that might fluctuate based on business activity, like raw materials, manufacturing expenses, commissions, and shipping costs.
6. Predict One-Time Expenses
Plan for irregular or one-time expenses you know will occur during the budget period. This might include buying new equipment, launching a marketing campaign, or any other significant outlays that aren’t recurring.
7. Forecast Cash Flow
Ensure that your expected revenues will cover your expenses. This step is crucial for businesses to avoid cash shortfalls. Remember, even profitable companies can fail if they run out of cash.
8. Adjust for Profit Margins
Adjust areas to ensure you hit desired profit margins after tallying all revenue and expenses. This could involve reducing costs or focusing on increasing sales and revenues.
9. Review and Adjust Regularly
Once you have a budget, it’s not set in stone. Regularly compare your budgeted amounts to your actual figures. Adjustments might be necessary as the business landscape evolves or unexpected events occur.
10. Seek Feedback
Involve key stakeholders, such as department heads, in the budgeting process. They can provide valuable insights into specific operational costs and potential revenue streams that might not be evident at a higher level.
11. Plan for Contingencies
Always set aside a portion of the budget for unforeseen events or opportunities. This “rainy day” or contingency fund can be a lifesaver in tough times or when unexpected costs arise.
12. Use Budgeting Tools and Software
Leveraging modern budgeting tools or software can simplify the process, ensure accuracy, and make adjusting and forecasting as needed easier. Many software solutions also offer visualization tools, making comprehending and analysing data easier.
13. Review and Finalize
Once all inputs are in place, review the budget holistically. Ensure that it aligns with your business goals and objectives. After this, finalize and disseminate it to relevant stakeholders.
Why do I need a small business budget?
A business budget is more than just a tool to keep track of spending. It’s a roadmap, a strategic tool, and a measure of a company’s health and potential. Here’s why having a budget is crucial for small businesses:
Firstly, a budget offers financial oversight and control. Having a clear picture of your finances gives you a sense of where your money is going and whether you’re meeting your financial objectives. This granular view is vital for ensuring sustainability and profitability.
Furthermore, informed decision-making becomes significantly more accessible with a budget. When faced with strategic choices, such as launching a new product or investing in marketing, a budget provides the context needed to weigh potential costs against benefits.
Managing cash flow is another primary concern for businesses, especially smaller ones. Cash flow disruptions can be a significant challenge, even for profitable entities. A budget anticipates income and expenses, ensuring adequate cash is available for operations.
Preparation for uncertainties is another advantage. The business environment is unpredictable. However, a budget can help you earmark funds for unforeseen expenses, ensuring you can handle financial curveballs.
Setting clear financial goals is essential for growth. A budget isn’t just about tracking expenses; it’s also about defining and aiming for targets. Periodically comparing actual results with budgeted figures can provide insights into performance and highlight improvement areas.
Efficient resource allocation is yet another benefit. By understanding where resources yield the highest return, you can judiciously allocate funds to maximize growth and profitability. This budget-driven focus can also help monitor and potentially reduce costs without compromising quality.
Stakeholder confidence can’t be underestimated. Demonstrating that you have a well-planned budget can signal professionalism and foresight to investors, lenders, and even key employees, ensuring they have faith in the business’s future.
Lastly, a budget acts as a guide if growth is on the horizon. It provides insights into how much you can reinvest to expand your business without overextending your finances. It ensures compliance and accountability, especially in sectors with strict financial regulations.
