A study by Clutch found that 50% of business owners in 2020 did not have a working budget. Maybe it's because budgeting can be a source of anxiety, or perhaps business owners do not know how to create a business budget — or fully understand why it’s important.
In this article, we are going to highlight the eight steps to creating a business budget because it requires more than simple addition and subtraction. We will also discuss why you need to have a business budget and why it is crucial to your success.
What Is a Business Budget?
To begin, we need to address what a business budget is and what it is not. A small business budget is not a reconciliation sheet where you add up your profits and losses and determine your profit margins. That is part of the budget, but it's not the entire budget.
Think about your budget as a living document. It is something that you come back to every month and review and adjust when necessary.
A business budget is like an action plan. It helps you plan your expenses and identify when you need to make adjustments. It gives guidance to your long term decision-making and can help predict when financial troubles could arise so you have time to act.
Why Your Business Needs A Budget
There are many reasons why your business needs a budget. Like a personal budget, a business budget helps you plan for future expenses. It forces you to look at the coming months or years and consider where you need to be financially. It also helps determine where you want to be and what events could derail you.
If you are starting a business for the first time or are adding another location, a business budget helps you understand what you need to hit the ground running. A budget aids in understanding what revenue you need to be successful. A well-thought-out business budget also helps you track your profits and expenses so you know if you can invest in your company or if you need to tighten the reins.
Now that we've covered what it is and why you need it, here are the eight steps for creating a business budget.
1. Gather Your Financials
To complete your business budget, you need to gather all of your available information — such as your monthly expense reports, revenue reports, accounting/booking information, and bank statements.
If you are a new business owner, you won't have a financial history to draw from, so you need to do a little market research. Ask some business owners in your same industry, research the typical expenses for your industry and business size, speak with a business consultant, and ask other knowledgeable individuals to get an estimate.
2. Calculate Your Revenue
After you gather your financial information, add up your income streams. Add up all of your revenue for the previous year or two because that will give you a baseline for the upcoming year. If your business suffered from Covid in 2021, calculate your revenue from 2019. Examples of revenue streams include:
- Product Sales
- Grants
- Loans
- Savings/Investment on your dividends
If you are starting a new business, this will be a little more like guesswork. Once again, research will be helpful to give you a baseline to start. Understand that your new business will not be making the same as an established business, so research and consult with industry experts.
3. Identify Your Fixed Costs
The third step is to identify your fixed costs. A fixed cost is an expense that remains stable over a week, month, or year. It can be helpful to identify the fixed costs in these three periods of time to ensure you account for everything.
Some examples include rent, payroll (including yourself), supplies, website hosting, insurance, accounting software, bank fees, cell phone, loan payments, etc. It’s also important to determine if any of these could go up this year, as that will play into your calculations.
4. Mark Out Variable Expenses
Fourth, mark out the variable costs that your business incurs at shifting rates. Examples of variable expenses include utility costs, raw materials, marketing, advertising, shipping, travel costs, etc. These are often referred to as "discretionary expenses."
5. Consider One Time Expenses
Another expense category that businesses incur is one-time expenses. These are items that your business may purchase once during the year. Examples of one-time expenses include equipment purchases, computer/software updates, new furniture, interior decorating, landscaping, conferences, large marketing campaigns, etc.
6. Project Your Future Revenue
Now that you have identified your past income, it's time to project it into the future. Forecasting your revenue month-by-month for the next year is important for a couple of reasons. It creates a clear goal for you and your team to aim for and it keeps you accountable to your budget.
If you know you need to make $30K a month to keep your business open (and pay yourself and your employees), you will be more motivated to stick to your operating budget and exceed your required income.
So how do you calculate your projected revenue? Begin with your cost requirement and what you absolutely need to keep your business open. Your projected revenue needs to be at least this much plus 10% for some wiggle room.
If you have a growth history to work from, use that. Take the current month or year's revenue and subtract the prior month or year's revenue from it. Then divide that number by the prior period's revenue.
For example, let's say your revenue is $50K for this month and it was $48,000 for last month. This is how you would calculate it:
(50,000-48,000 = 2,000. 2,000/48,000 = 0.041666. 0.04166*100 = a monthly increase of 4.16%)
Then, multiply your current monthly revenue by the increase and add that to your current month's revenue to get your next month's projected revenue. Using the example above, you would calculate your next month's projected revenue like this: (50,000*4.1%=2,050. 2,050+50,000= 52,050).
Your projected revenue for next month would be $52,050. Now, when you are making your business budget, the best practice is to do this for a year at a time, because monthly revenues fluctuate.
7. Put It All Together
Now that you have gathered your financials and made your calculations, you have everything you need to make a detailed budget plan and your profit and loss statement, or P&L.
Add up all of your expenses (both fixed and variable) for one month — this is the amount of money you must make to break even each month. Add all of your monthly expenses, yearly expenses, and one-time expenses. This is what you must make over the course of the year to break even.
At the end of each month, subtract your expenses from your revenue to determine whether you were in the red (negative) or black (positive). As the year progresses, track your actual revenue against your projected revenue to see if you fell below or exceeded your projections. You will use your actual revenue to project your revenue for the following year.
8. Create An Emergency Fund
Instances happened that we just can't plan for; Covid reminded us of that fact. To guard against future emergencies, save money and create an emergency fund.
The best practice is to save three to six months of expenses and have it on hand should you need it.
Get one month's expenses in the bank as quickly as possible, then continue to save until you have at least three to six months of expenses saved up. You will be thankful that you did.
What To Do If You Exceed Your Budget
Going over budget can happen to even the most diligent planners. When it happens, it's a good idea to have a plan B or a backup plan. There are a few options for you to consider, but one viable option to guard against emergencies is to have a line of credit ready to go.
With a line of credit, you only pay for the amount that you borrow. Two of our partners, BlueVine and Fundbox, offer competitive lines of credit, up to $250K and $150K, respectively. Lines of credit can also be used to increase cash flow when accounts receivable are outstanding.
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