Create a Business Budget in 3 Simple Steps (A How-To Guide)
When it comes to hitting quarterly goals, every penny counts. The key to tracking spending, monitoring profits margins, and expensing losses for future success all boils down to your small business budgeting. Budgets are how you quickly identify challenges and allocate the financial resources to fix them before resources run out and your company becomes another failed statistic.
If you don’t have a business budget quite yet, you’re not alone—as many as 61% of small businesses didn’t create a budget in 2018, according to a recent Clutch study. Many startup entrepreneurs aren’t sure how to create a budget, don’t see the value in making one, or feel as though it’s just one more hassle to add onto their already-full plate.
The truth is, skipping a budget only creates more problems by complicating financial monitoring and decision-making. We’re here to break the process down into three easy steps, provide you with business budget examples that you can adapt as your own, discuss the key components therein, and offer ways that you can make your accounting processes much easier. Click on a link below to learn more.
- Small Business Budget: Key Components
- Step 1: Calculate Startup Costs
- Step 2: Make Financial Projections
- Step 3: Create then Re-Evaluate
- Professional Business Accounting
Small Business Budget: Key Components
Before we dive deep into the art of small business budgeting, it’ll be helpful to clarify some business terminology. That way, you’ll know exactly what we’re referring to when we discuss the key components of a budget template and the steps you should take to create your startup’s own budget categories.
● Sales and Revenues
These figures are the cornerstones of your small business budgeting, so try to make your estimates as accurate as possible. The best way to predict your annual sales revenue is by looking at last year’s numbers, but if you’re just starting out, you can conduct market research to come up with a fair estimation. Note: Always err on the side of conservative.
Remember to keep your small business taxes in mind as you project for the future year(s), including any net operating losses you might report, or deductions you might claim.
● Total Costs and Expenses
The next step toward creating a business budget will be figuring out how much it will cost your company to earn its projected revenue. This might prove challenging due to price fluctuations and market inflation, so it’s best to break up your costs into three separate categories to budget accordingly.
- Fixed Costs – These expenses remain the same on a monthly basis (regardless of your sales) such as the cost of rent, price of insurance, and so forth.
- Variable Costs – Variables, such as the price of raw materials needed to produce goods, typically correlate with sales and increase as business increases.
- Semi-Variable Costs – This category applies to expenses that are typically fixed, but variable when influenced by the volume of business. Good examples of semi-variable costs include employee salaries, advertising campaigns, and equipment expansion.
Ultimately, your business budget should operate according to a basic mathematic equation:
Sales Revenue – Total Costs = Profit
You need to make profit to stay in business and see a return on your investment, so your budget should make use of this simple formula to ensure your company stays in the green. If you make a business budget template and find that your profits would be unsustainable, you’ll need to play around with your projected costs and see where you could save money throughout the year.
That might mean lowering the expense of rent, utilities, and office supplies by downsizing to a remote office, or you may decide to outsource positions in order to cut down on employee labor. Alternatively, a budget that shows plenty of room in the profit margin might mean that you can begin planning a move to a bigger location, buying more equipment, or hiring more staff.
Takeaway: Live and breathe by your profit margins, leaving yourself ample wiggle room that can cover unanticipated variable expenses. That way, you’ll know that you have enough cushion built into your budget to weather random curveballs and temporary storms without being entirely taken out of business.
Step 1: Calculate Startup Costs
The first step in creating a small business budget is highly critical for entrepreneurs who haven’t quite launched their companies off the ground. The reason being, is that all of your potential lenders—whether it’s a bank or venture capitalist—will more than likely require an estimate of your anticipated startup costs.
You can come up with an amazing budget, capable of impressing even the most astute Harvard Business grad, but if you fail to consider how your initial expenditures will impact your monthly budgeting, you could be drowning in debt before you know it, doomed to fail before business is even open.
Lenders compare expected costs to projected revenue in order to determine your potential for profit—and, correspondingly, how much funding they’re willing to offer to help you succeed. For that reason, it’s important to make sure your projected numbers are presented in a format that’s clear and easy to understand.
The Small Business Administration (SBA) offers a budgeting template to help you calculate what it might cost to start your business. Unique items included within their budget example for one-time, startup expenses include:
- Establishing tenancy (security deposit, first month’s rent, first month’s utilities)
- Improvement costs (such as necessary furniture or equipment upgrades)
- Inventory expenses
- Miscellaneous items (legal fees, signage, software, etc.)
Calculate these startup costs to estimate the total funds required to start your business. Then, subtract the amount of personal capital you plan to invest in your business from its projected startup cost—this figure equals the amount of funding you will need to acquire in order to open for business.
Next, make sure that your budget for the first month (or first several months) of operation reflects any added expenses which your up-and-coming business could incur. This might include mandatory loan payments, as well as consulting fees, marketing materials, and organizational dues.
Pro Tip: As your company grows, monitor how your expenses change. The semi-variable cost of advertisement might decrease as your referral base grows, but as you hire more employees and find the need for , you might need to readjust your budget.
Step 2: Make Financial Projections
SCORE, a nonprofit organization dedicated to helping entrepreneurs, offers a number of small business budgeting tools that are free to use. Take advantage of all their resources, but especially their financial projections template during step two of your budget creation.
Downloading this free budget tool will help you calculate financial projections including your startup expenses as well as your sales forecast, income statement, balance sheet, cash flows, break-even analysis, financial ratios, payroll costs, costs of goods sold, amortization and depreciation of your small business.
● Sales Forecast
Sales forecasting refers to the process of estimating future sales based on company data, industry-wide comparisons, and economic trends. An accurate sales forecast within your small business budget will help establish a forecasted profit margin which you’ll use to make informed spending decisions throughout the year.
● Income Statement
One of the three most important documents for monitoring the financial performance of your business (the other two being the balance sheet and statement of cash flows), this document reports income and expenses during a particular fiscal period—and will become incredibly important when it comes time for your small business tax prep. Examples of categories might include:
- Revenue – Money received by a company within a given period
- Gains – Increase in the value of an asset or property (i.e. the sale of a van)
- Expenses – Economic costs a business incurs to earn revenue (i.e. wages, rent)
- Losses – The cost of losses incurred within a given period
● Balance Sheet
Whereas an income statement (sometimes called a profit and loss statement) tends to focus on a company’s revenues and sales, a balance sheet takes double entry accounting into effect and considers a company’s assets, liabilities, and shareholder’s equity.
● Cash Flows
Cash flow is the net amount of cash that an entity receives and disperses within a given amount of time. This figure is very important for small business budgeting, as a positive cash flow is necessary to stay in operation; if more money is withdrawn than the amount that comes in, a business is then in danger of being overdrawn and will be forced to cover potential overdrafts from unchecked spending (usually, with working capital in the form of loan or line of credit that results in more interest and more debt).
You can find the cash flow budgeting template on page 6A of SCORE’s template for financial projections, or download their separate budget example that goes into further detail with additional categories for cash paid out, such as:
- Purchases (i.e. Merchandise)
- Gross Wages
- Payroll Expenses
- Outside Services
- Repairs & Maintenance
- Gas Mileage & Travel Expenses
- Rent & Utilities
The bottom line is that all cash—incoming and outgoing—should be accounted for down to the very penny within your small business budget.
● Break-Even Analysis
The break-even analysis represents how many units you must sell for your revenues to equal your expenses; any unit sold beyond this break-even point allows your company to generate income. By including this figure within your small business budget, you’ll be able to play around with different financial scenarios that will give you a better picture of your circumstances as a whole.
For example, if you add an extra employee to your payroll, how many additional dollars will you need in sales? If you borrow money, how much will you need to recover the principal and interest? A break-even analysis is a great budgeting tool that gives you a goal to shoot for in order to stay in the green.
● Payroll Costs
Most small business owners budget for the cost of employee wages, but many fail to anticipate the burden of employee taxes, withholding, and reporting. According to the IRS, the current employer tax rate (2019) for Social Security is 6.2%; Medicaid is 1.45%. Employers are also responsible for depositing employment tax, as well as paying for federal (and state, if applicable) unemployment tax.
Be sure to account for all of these payroll costs within your small business budget to stay out of hot water with the IRS. Also include any costs directed toward benefit packages your company may offer. To ensure you’re in good standing and that you can make ends meet, you might want to consider outsourcing payroll services to professionals.
● Costs of Goods Sold
The costs of goods sold (COGS) sounds straightforward, but this formula requires careful calculation and is integral to your business budgeting and decision-making. The figure itself refers to the direct cost of the raw materials and labor needed to produce a good or service sold by your company, but it has (or should have) a significant impact on your pricing structure.
Pricing your goods and services correctly is a huge business responsibility, but if you know your COGS, you can set prices that leave you with a healthy profit margin.
Once you know the COGS, you can subtract that figure from your total business revenue to calculate the gross profit. You can also determine when you need to increase the price of a particular product, or cut down the cost of its production, to optimize your profit margins.
For example, if you own a woodworking business, your COGS might include the cost of wood, screws, paint, and labor required to build a cabinet—but it would not include certain indirect overhead expenses, like the cost of utilities needed to complete the job.
If revenue from the job equals 100%, and the cost of goods sold amounts to 70% of your revenue, then that means your gross profit is 30%. Depending on whether or not that profit margin is healthy for your industry, you could explore ways to find cheaper raw material, less expensive labor, or markup the price on the finished product for better numbers.
NYU Stern publishes a list of U.S. profit margins by sector that you can use as a temperature check while learning how to manage a budget in business.
Simply put, amortization is a strategy for spreading out costs over a period of time. Small business owners typically amortize items such as loans, rent or mortgages, annual subscriptions, and intangible assets (patents, copyrights, etc.).
The IRS allows companies to write-off certain amortized expenses, thereby lowering the company’s tax obligation and increasing its bottom line. This allows accountants to expense items in the fiscal periods they are used, which will supply you with a much clearer picture of how business is performing and whether or not you may need to tweak your startup budget.
Unlike amortization, depreciation refers to the expensing of a fixed (tangible) asset over its “useful life”. Examples of these assets might include buildings, equipment, office furniture, vehicles, land, and machinery.
Essentially, companies use depreciation to spread the cost of a large capital expense over the number of years it will be in use, and this expense should be included within your budget. When creating a business budget, establish a threshold for which any cost above a certain amount should be capitalized as a “fixed asset” rather than expensed outright.
For example, if your capitalization threshold is $1,000, then small tools, equipment, furniture, and items that cost less than $1,000 will be fully expensed in the fiscal year they were purchased. Purchases that cost more than that, and will be used for more than one year, should be capitalized and then depreciated over the years of its useful life.
Within your financial projections, create a fixed asset schedule that calculates the amount of depreciation necessary to operate moving forward. If you fail to consistently include depreciation within your budget, you might eventually erode your company’s net assets.
SCORE’s workbook provides entrepreneurs with a wealth of small business budgeting tools, but there’s one last step to proper budget management.
Step 3: Create then Re-Evaluate
After calculating your startup costs and making your financial projections, it’s finally time to evaluate your data and create your small business budget. The work isn’t over with this third step, though, as you’ll need to continuously revisit and re-evaluate your business budget on a monthly and yearly basis.
In order for your budget to work as intended, you need to take a look at the past several weeks’ performance and expenses. How does your sales forecast look for the upcoming month? Were expenses as expected? Do you need to make adjustments to accommodate staffing or inventory needs?
Analyzing these numbers—and adjusting them accordingly—is the ticket to staying in the green, and ultimately, growing your small business profits. If you lost an important account, check how this affects your cash flow and what you need to do to balance the loss of revenue. Maybe you’re under-investing in marketing; tweak that budget category and watch how the increased spending affects your revenue gained.
Professional Business Accounting
If these three steps to creating a small business budget sound stressful, or not so simple, then you might consider professional accounting services that can pull the data for you. With the Community Tax team of experts on your side, you can stop worrying about crunching numbers and running formulas, instead keeping your vision focused on running your company.
Let us handle your monthly bookkeeping, and use the accurate information we provide to strategize your small business budget to soar profits to new heights. When you’re ready for a free consultation, the Community Tax pros are here to help.