Whether you’re just starting a new business or you’re already a small business owner, a business budget will help you assess your expenses, income, and overall business performance to ensure the long-term profitability of your business model. That’s why we’ve created this simple guide to walk you through the business budgeting process and show you how to create a budget that works for your business.
What is a business budget?
Before we dive into what information you need to include when creating a budget, it’s important that you understand what a budget for your business is and how it can help your business. In short, a budget is a detailed plan to help you manage your money and track your finances. It usually uses data from your previous year in business, as well as any relevant market trends in your industry, to predict how your business will perform in the next year. While many small business owners create a budget for the fiscal year, you can also choose to work in smaller periods of time by reassessing your budget at the end of each quarter.
If this is your first year as a business owner, don’t worry! Instead of relying on information obtained from your last year in business, you may need to do some market research into predicted sales volume, startup costs, and variable expenses within your industry.
When you create your budget, you will need to come up with a breakdown of the funds you will have available and how they should be allocated. By creating your business budget, you can avoid unnecessary costs that could cut into your profit or even send you into debt.
Depending on your business, your budget can be either static or flexible. Let’s take a closer look at what each of these terms means.
When you are working with a static budget, your budget will not change throughout the period of time it covers, regardless of external factors like an increase in sales or the cost of raw materials.
A flexible budget is more open to change. As you receive new information about your actual sales, production, and other economic factors, you can adjust your business budget to suit the changing needs of your business.
In addition to being static or flexible, your business budget will fit into one of the following categories.
When you have a surplus budget, that means that your profit is expected to exceed your expenses, so that you end up with a surplus of extra money.
A balanced budget means that your anticipated income and expenses are equal, so your business should break even.
If your budget is in deficit, your expenses are higher than your revenue, which is a good indication that you need to reassess your budget and find ways to bring in more income and cut costs wherever possible.
Now that you understand what a small business budget is and the various categories it can fit into; it’s time to explore why you need to create a business budget.
Why do you need a business budget?
Creating a business budget is an integral part of starting and running a successful business. With accurate business budgeting, you’ll be able to make sure that your business is profitable by narrowing in on your profit margin. This will give you a thorough understanding of what needs to be adjusted in your current small business operations in order to become more efficient and lucrative.
If you’ve already been running your small business successfully without a budget, you may wonder whether you even need to devote the time and effort to the business budgeting process. In addition to giving an overview of your business revenues and spending, budgeting can help you achieve long-term success by bringing attention to areas that need more consideration.
By creating a budget every year you’re in business, you’ll be able to use your improved clarity to accurately set goals, priorities, and spending limits, as well as identify new opportunities to increase cash flow and measure how performance is lining up with your expectations. A history of detailed, accurate budgets will also come in handy should you need to apply for loans or pitch your business to potential investors.
Now that you understand why budgeting is a good idea for small businesses, it’s time to take a closer look at what your budget should cover.
What should your budget include?
When you start creating your budget, you’ll need to gather information to see how much money you are making compared to how much you spend. This will mean making a note of numbers like your production costs, business expenses, profits, shipping costs, and any other relevant financial information.
In addition to looking at your financial performance over the course of the last year, it’s a good idea to break it down further to see how your finances vary on a monthly basis. Most businesses experience peak seasons where sales are higher, and having this information can help you to anticipate your revenue and expenses for each coming month.
By comparing your business costs and revenues based on sales history, you’ll be able to forecast your projected cash flow. Make sure that you also remember to make a note of any big purchases you will need to make in the future, even if it won’t be happening in the time period covered by your budget so that you can start saving now.
While your business’s financial history is a crucial component for creating accurate small business budgets, you’ll also need to look at external factors like changes to your industry, customers, and competition.
It may surprise you, but a business budget is about more than finances. You should identify your key objectives and outline what operational changes you will need to make in order to achieve your goals. A budget may cover an entire year, but it’s important that you regularly check in and measure how your performance is comparing to the expectations set out in your budget so that you can adjust things if necessary.
How to create a business budget in 6 easy steps
If you’re feeling overwhelmed by all of this information, we’ve got you covered. Just follow these six simple steps to create a business budget that clarifies your business’s focus and how you intend to achieve all of your goals.
1. Look at your revenue
Start by calculating your sales revenue as well as any other income, like interest on your savings or investments. Keep in mind that revenue refers to the total amount of money from sales, whereas your income is what you make after subtracting your expenses.
Add together all of your income sources to find your past yearly and monthly revenue. This will help give you an overview of which months are busiest to plan for when you might need to increase your marketing budget or hire additional employees.
2. Determine your fixed costs
The second step to creating your budget is to look at your fixed costs, which are expenses that don’t change depending on your sales or production volume. Sometimes referred to as indirect costs, these can include things like property tax, salaries, office space rental, employee benefits, insurance, utilities, bank fees, and office supplies, just to name a few.
Once you have calculated your total fixed costs, subtract the number from your revenue, which you calculated in the first step.
3. Determine your variable costs
Unlike fixed costs, variable costs refer to expenses that change in relation to your production output. Since costs tend to rise with increased production, as your business grows, so will your expenses. Examples of variable expenses are raw materials and packaging, sales commissions, and direct labour costs.
When you subtract both your fixed costs and your variable costs from your revenue, the number you end up with will represent your profit.
4. Create a contingency fund
Running your own business can mean endless earning potential, but it also comes with its fair share of unexpected twists and turns. A contingency fund, also known as an emergency fund, is a reserve that’s set aside so you can cover expenses or one-time costs that you didn’t anticipate. This could be an increase in the cost of supplies, repairing or replacing equipment, or lower sales than you projected.
While your contingency fund doesn’t necessarily have to be in cash, you should make sure that it is easy to access immediately in case of emergency. Ideally, your contingency fund should grow over time through reliable stocks or bonds while remaining relatively stable.
Having funds that you can quickly access can help you avoid taking out additional credit or loans. Plan for a percentage of every month’s income to go directly into your contingency fund in your budget.
5. Create a profit and loss statement
A profit and loss statement, also known as an income statement, is a type of financial statement that summarizes your revenues, costs, and expenses for a specific period of time, usually a quarter or fiscal year. It will demonstrate the profitability and financial performance of your business.
To create this statement, add up each month’s profits and subtract your expenses. Ideally, this would leave you with a positive number, indicating that you brought in more money than you spent. However, keep in mind that you can’t expect every month to be profitable, especially when you’re just starting out as a business owner.
6. Outline your forward-looking business budget
For a forward-looking business budget, you need to emphasize predicting future behaviour. The longer you’ve been in business, the more information you’ll have to draw on to create an accurate forecast. While your profit and loss statement shows past behaviour, a forward-looking business budget predicts the future of your business. Use the information from your income statement to inform your decisions as you plan for the coming year.
Helpful business budgeting tools
It can be difficult to justify investing in a bookkeeper when you’ve barely started making sales in your new business. Luckily, there are lots of lower-cost options for business owners to help you get a handle on your expenses.
Quickbooks is an all-in-one accounting software designed specifically with small businesses in mind. It allows you to track your expenses and income by connecting your bank accounts, credit cards, and PayPal all in one place. Quickbooks also automatically suggests tax categories so that you can keep your information organized.
In addition to a bunch of other nifty features, you’ll be able to stop saving your receipts in a messy drawer by taking advantage of the ability to upload a photo of every receipt and keep it safe and organized.
Xero helps you keep your business running smoothly with automated invoicing and reporting. You can collaborate with your employees in real-time, and they’ll be able to submit their expenses, manage leave, and send invoices all through the same program. You can even customize your account with over 800 third-party apps in Xero’s marketplace and get a full picture of your business finances at a glance.
Not only does Freshbooks allow you to log and organize your expenses easily, but it also uses double-entry accounting to ensure accuracy and compliance. You can track your time and automatically record it on your high-quality, professional invoices, and the mobile app means you can do your accounting from anywhere.
PlanGuru helps small businesses get access to the same level of financial analysis as big corporations at a fraction of the cost. With its integrated income statement, balance sheet, and cash flow statement, you can do a full financial review in just a few clicks. It also helps you prepare for contingencies with its forecasting tool and scenario analysis.
Now that you know more about how to create your business budget, you’re ready to get started.
This article offers general information only, is current as of the date of publication, and is not intended as legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. While the information presented is believed to be factual and current, its accuracy is not guaranteed and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author(s) as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by RBC Ventures Inc. or its affiliates.