Last Updated November 3, 2023
Creating a budget is essential when running or starting a small business. When doing so, setting attainable goals, knowing your limitations, and understanding the best business budgeting tools will give your small business the best shot at profitability and sustained success.
Continue reading to learn more about the benefits of budgeting for your small business, a step-by-step guide for creating your budget, and the tools at your disposal to help you along the way.
Benefits of a Business Budget
A business budget is essentially a plan for your money. This budget plan doesn’t have to be complicated and extravagant, but it should cover a few basics. Budgeting offers the following benefits:
- Helps maintain financial organization: A business budget is the financial blueprint for your business. Every small business owner should create two things when starting a business: a budget and business plan. Doing so will ensure you’re entirely organized when starting your company.
- Enhances future decision-making: Budgeting leads to identifying areas of improvement, particularly whether or not your small business has enough capital to succeed.
- Assists with preventing negative cash flow: Most small business owners will deal with negative cash flow at some point, but properly budgeting means you have accounted for your future cash flows and are confident you’ll be able to break even.
- Informs you if additional funding is necessary: Creating a business budget allows you to better understand whether you might need additional funding to reach your growth goals for the next year. You can then begin researching alternative lending options, which prevents you from scrambling on the fly once your business is already knee-deep in debt or has prolonged negative cash flow.
- Signals opportunities for investments: After budgeting, you may find that you have money left over. This means you can feel comfortable exploring investment opportunities without worrying that doing so will hinder your business’s growth.
Eventually, you’ll find that creating a budget for your small business will have helped you successfully filter excess income into investment opportunities, increase revenue, improve cash flow, and maintain organization.
How to Create a Small Business Budget
When budgeting, you must have a thorough understanding of the exact amount of money available to you, how much you spend, how much you can acquire, and how much you need to distribute into other areas.
Let’s walk through creating a small business budget in seven steps.
1. Calculate Available Funds (or How Much You’re Willing to Spend)
When budgeting, creating a business plan, or performing any business-related activity, it’s always important to remember the big picture. Calculate and keep in mind how much money you’re willing and able to invest in your business before getting started.
2. Determine All of Your Costs and Expenses
Once you know exactly how much money you have, add up all of your known and projected costs and expenses. This can include paying employees, insurance plans, purchasing new equipment, paying vendors, and business expansion-related costs, if applicable.
3. Project Your Annual Revenue
Now, it’s time to project your revenue for the next fiscal year. Before doing so, remember that revenue is not the same as income.
Revenue, which should be found at the top of your company’s income statement, is the total income your business generates from all sales-related ventures. Income accounts for money earned after all expenses are subtracted.
You can use this projected figure to help calculate other financial measures, such as projected gross profit margin.
4. Calculate Your Past Year’s Gross Profit Margin
To calculate the gross profit margin, take your gross profit, divide it by your revenue, and multiply that figure by 100. Then, express the resulting figure as a percentage.
The formula reads as follows: (Gross Profit/Revenue) x 100 = Gross Profit Margin
For example, for a business with a gross profit of $16,000,000 and revenue of $112,000,000, the formula would read as follows:
Gross Profit Margin: (16,000,000) / 112,000,000) x 100 = 14.28%
Completing this step will help you better understand what your gross profit margin will, or should, look like for the following fiscal year.
5. Project Future Cash Flow
There are few things more important for business owners than managing cash flow. By creating a cash flow forecast, you’ll be able to analyze whether you can afford to take on new projects that you may not have planned for when building your business budget.
6. Create a Profit and Loss Statement
The profit and loss statement (P&L statement), also known as an income statement, will give you an idea of what you can do with leftover cash and where you could mitigate losses or increase revenue.
This statement is the key to increasing cash flow and budgeting properly because it creates a snapshot of your company. You can plan around this statement and budget accordingly.
Points of interest are as follows:
- Inventory purchasing
- Licensing costs
- Seasonal revenue changes
- Yearly revenue changes
- Expense changes
7. Start Goal Setting
Perhaps the most enjoyable step in building a small business budget, goal setting is crucial because it sets benchmarks and milestones for your business to attain in the following year. Don’t forget to devise steppingstones for how you’re going to reach your financial goals as well. Doing so will keep you on track and help you build a blueprint for success.
It’s important to establish optimistic yet realistic goals. You don’t want to set yourself up for failure, but you also don’t want to set the bar too low.
8. Finalize Your Budget
Once you’ve ensured you have everything in writing, your final step is to subtract your fixed and variable expenses from your income, whether those are planned for the following year (if it’s your first year in business) or projected based on the previous year.
The next step in creating a reliable budget is to subtract your fixed costs, followed by your variable costs.
Fixed costs are what you expect. They’re expenses that will remain constant throughout your operating period. Expected fixed costs are rent, banking fees, insurance, services, licenses, and leases.
There are considerable fixed costs, but you correctly identify them by understanding the length of payments and the amount over some time. Fixed costs can disappear, but they’ll stay consistent, so you know what you’ll be paying with no surprises.
Variable costs are another category of expenses. Variable costs consist of items or services that change in price. These variable costs are a bit unpredictable, and they may interfere with your budget planning.
Common variable costs are manufacturing, shipping, labor, travel fees, and raw materials. The reason these costs vary is that they’re dependent on other factors. For example, if a job becomes too difficult or easy, labor costs will fluctuate because of hourly rates and other optimization adjustments.
Once you’ve deduced how much money you might have leftover, you can begin planning out how to use that money effectively and efficiently in order to reach your small business growth goals.
Limitations When Building a Small Business Budget
Like any plan, budgets have inherent flaws, and that flaw is being unable to predict the future. Not everything will go according to plan, and because emergencies and variable costs exist, you may find yourself adjusting around those costs often.
To mitigate these weaknesses, it is recommended to leave emergency funds to compensate for a lower-than-average revenue or higher-than-average expenses. It is important to note that sometimes emergency funds act as idle cash, and some businesses may not like the idea of idle cash lying around.
Putting that emergency cash into a savings account will allow it to accumulate interest while also acting as a safety net for potential emergencies.
The first budget you make will consist of estimates, but as your year comes to a close, you’ll begin to have a stable and more accurate foundation to help with your budget.
Sometimes budgeting is a trial-and-error process, but the more accurate your numbers become, the more reliable your budgets will become.
Small Business Budgeting Software
If you still feel overwhelmed by the amount of planning that goes into creating a business budget, there are several small business budgeting software tools that can help.
Quickbooks in particular is regarded as one of the best small business budgeting software tools. Quickbooks is considered a pioneer in the accounting realm thanks to highly customizable features that can greatly reduce time spent on even the most complex accounting tasks. The best part is that plans start as low as $30 per month.
Zoho is another small business budgeting software tool. While Quickbooks specializes in accounting, Zoho’s strongest capabilities are geared toward automating workflows and tracking profitability for various projects.
In Summary: Your Small Business Budget
Every business budget must be flexible. The business and economic worlds are constantly changing, which affects your costs and expenses. When planning a budget, keep in mind that much of your document will include variables and estimates. Additionally, ensure you’ve set optimistic but realistic goals and that revenue is distributed accordingly. As a small business owner, expect the best but prepare for the worst.
Michael McCareins is the Content Marketing Associate at altLINE, where he is dedicated to creating and managing optimal content for readers. Following a brief career in media relations, Michael has discovered a passion for content marketing through developing unique, informative content to help audiences better understand ideas and topics such as invoice factoring and A/R financing.
