For many entrepreneurs, creating a business budget sounds great in theory. But in reality, they’re busy enough trying to make sales, run their business and make sure there’s enough money in the bank (or available room on the business credit card) to make it to the next month. Planning is a task that just gets put on the to do list.
If that sounds like your business, take a moment to pause and consider why the budgeting process can be valuable to your business. It can give you valuable data about your business along with a direction for using that data to make smarter financial decisions. Here’s how to get started.
What Can A Good Budget Do For Your Small Business
In the budgeting chapter of “Finance Basics,” Harvard Business Review says, “You need to understand the company strategy in order to create a useful budget.” But, no matter how strategic your budget, it’s only useful if it actually gets used.
A business budget can have multiple benefits, including:
Reduce expenses. With a budget you’ll review where you intend to spend money, and that can lead you to think more carefully about those purchases.
Make better financial decisions. Instead of reacting to what happened in the past, you can be proactive about where you dedicate resources. You may decide to make changes in pricing, for example, even eliminate certain products or services.
Reduce Stress. Taking some time to create a business budget can free you from some of the stress that goes along with running a business.
Build financial health. A budget is a key step in building a financially healthy business.
While it doesn’t put money in your bank account today, a budget can ultimately help you spend time, money and resources more strategically. Ultimately, understanding your financial information helps put you in control.
7 Steps to Creating a Small Business Budget
So how do you go about creating a budget for your business? Whether you’re a startup or seasoned small business owner, here are seven simple steps you can take to get started:
Step One: Start with Sales
The first step in creating your budget is to understand how much revenue your business will bring in during the budget period. (You can create annual, quarterly or even monthly budgets.) How much money do you expect to make, and what are your expected income sources?
Established businesses may be able to use the previous year’s sales as a benchmark, while new businesses will have to create sales projections based on information about the industry and market conditions— .
Business planning software can help you estimate the amount of money you’ll make under various scenarios. Some come with industry benchmarks to help you create realistic projections.
Step Two: Budget for Fixed Costs
You need to budget for fixed costs. These are expenses your business must pay regardless of how many sales you make. They may include overhead expenses, such as rent or payroll, as well as expenses such as insurance, accounting, software etc. That’s not to say these expenditures are set in stone, but there tends to be less fluctuation than with variable expenses. Again, start with last year’s business expenses and think through what you expect in the coming year.
Step Three: Estimate Variable Expenses
Variable expenses change based on what your business produces and sells. These expenses fluctuate more than fixed expenses and often tie directly into the cost of goods sold. For example, while a salary you pay an employee would fall under fixed expenses, the commissions you pay a salesperson would fall under variable costs. You generally will have more control and discretion when it comes to variable expenses.
Step Four: Plan for One-Time Expenses
Think through infrequent expenses you’ll make during the budget period, and build in some room for unexpected costs. For example, is there a holiday coming up where you’ll need to buy gifts for clients or celebrate with employees? Will you need to exhibit at an industry conference? It’s easy to forget about these expenses that occur infrequently, and unexpected expenses will always crop up, but you don’t want either to blow your budget.
Step Five: Estimate Profits
An income statement (also called a profit and loss statement or P&L) will reflect the information above and help you understand whether your budget will work. You’ll be able to estimate your profit margin and focus on more profitable activities.
Since you’re projecting into the future, rather than looking at what’s happened in the past, business planning software can be very helpful here. You can also use Excel or another type of spreadsheet to make these calculations.
Step Six: Understand Timing
You may find when you’re creating your budget that you will make enough income to cover your expenses and leave a profit, but then discover that from time to time your business doesn’t have enough cash available to pay expenses that are due. This is a common cash flow problem for many small businesses. The income from sales doesn’t always come in quickly enough to pay expenses.
When cash flow is tight you may need short-term financing such as a line of credit or small business loan so you can meet your obligations while you wait for revenues to hit your business bank account.
Step Seven: Refine and Track
If you discovered during the process above that your budget doesn’t quite add up, you may need to make adjustments. You may need to negotiate contracts with suppliers or vendors, or postpone redoing your website, for example. The beauty of budgeting is that it forces you to think about different scenarios and lets you create contingency plans.
Use Your Budget To Stay On Track
Once you’ve created your budget, you can then track your business revenues and spending to stay on track, plan for the upcoming year, and adjust as needed.
Using the right accounting software and staying up to date on bookkeeping is essential to this process. Make sure you also use a dedicated business bank account and business credit cards to track income and business expenses.
Tracking and managing your cash flow, and taking the time to create a budget for your business will help you create a roadmap for success. You may take detours along the way, but with your budget as a guide you can get back on track more quickly and with confidence.