Business budgets are the foundation of economic success for any company, large or small. As a financial plan that outlines forecast revenues and expenses over a specific period, it provides a company with a clear framework for managing resources and making informed financial decisions.
Whether you’ve started or scaled your business, understanding how to create a business budget is essential to financial success.
Explore the basics of budgeting your business and the practical steps you can take to create and maintain a functional business budget.
What is a business budget? Why is it important?
A business budget is a financial blueprint that provides a detailed plan for the business’s income and expenses for a given period, typically a month, quarter, or year. A developed budget allows small business owners to estimate revenue and expenses, allocate funds for strategic priorities, plan profitability, and remain financially resilient in preparation for unexpected financial challenges.
Budgeting is essential for small and medium-sized businesses. This is because it provides financial clarity and helps avoid common mistakes such as overexpenditure and underestimation of costs. But business budgets, which are more than just a number of calculations, are also a strategic process, as they involve setting goals and allocating the resources needed to achieve them.
What is included in your business budget?
Budgets can take many forms, but every effective business budget includes several key components.
Revenue
Revenue is the gross revenue that a business expects to generate from the sale of its products and services. Estimated revenue is calculated by predicting sales and subtracting the estimated cost of goods sold (COGS) or services provided.
Established businesses develop revenue forecasts based on past performance adjusted to take into account recent market developments. In contrast, if you are starting a business, you need to rely on industry benchmarks or compare data from similar companies in your niche to build realistic forecasts.
You want to avoid overly optimistic revenue forecasts that could lead to unrealistic spending plans.
Fixed costs
These costs remain constant over time, regardless of the size of production or other business activities. For example, rent is a fixed monthly fee. It does not change based on the amount your business generates for a given month.
It is essential to include fixed costs in your budget. This is to show the minimum revenue a business needs to cover costs incurred regardless of business activity.
Variable costs
These are the costs that fluctuate in business activities. For example, producing more goods increases the cost of raw materials.
The easiest way to predict variable costs is to use historical data. Start by calculating the average variable cost per unit, taking the total variable cost from the previous year and dividing it by the number of units produced during that period. This number can then be multiplied by forecast sales over the next period to estimate the total variable costs.
One-time cost
One-time costs are non-repeat expenses that do not fall under normal business activities. These may include, for example, purchasing one-time software or equipment.
Repetition costs are generally easier to predict, but one-off costs are more difficult to predict. Here we will help you to align your budget with your procurement plan. If you are expecting significant costs, such as purchasing office equipment or software next year, for example, make sure to describe these as one-time expenses in your business budget.
Profit
Profit (net profit) represents the difference between revenue and total expenses, and reflects the profitability of your business. It is reported in the profit statement and is also known as the Profit and Loss (P&L) Statement.
Every business needs to track several types of profit:
- Gross profit Revenue is defined as variable costs such as the cost of goods sold.
- Operating profit – Also known as pre-interest and pre-tax revenue (EBIT) – includes only the net income generated by the business from normal business operations.
- Net profit – The conclusion or final profit count is after all expenses have been deducted from the total revenue.
Seven Steps to Creating a Business Budget
Creating a business budget is an essential process for ensuring financial security. Here is a step-by-step guide to help you create an effective budget.
1. Check past financial performance
Analyze financial statements such as income statements, balance sheets, and cash flow statements to identify trends and better understand revenue and expense patterns. At this point, you can perform a cash flow analysis over the past year, checking all revenues and expenses incurred over the year, and checking if you have positive cash flows.
2. Predict revenue
Estimate how much your business will earn during budgeting. Be conservative so you don’t overestimate your income. New businesses should look at industry averages and benchmarks to estimate revenue. You can also use your previous quarter revenue to estimate how much revenue you will generate in this quarter.
Also consider the number of income sources you have and whether any of those sources provide predictable income, such as monthly vassals. If you don’t already have it, you can also create multiple revenue streams within your business to set your business’ finances on a solid footing.
3. Identify project costs including fixed and variable costs
Classify operating expenses into fixed and variable expenses. Understanding these distinctions can help you allocate funds more effectively. To avoid surprises and make sure you are prepared for greater financial spending, include irregular expenses expenses categories such as purchasing new equipment or attending exhibitions.
4. Set profit targets
Decide how much profit you want to make during your budget period. Subtract estimated costs from the forecasted revenue. If the results are unsatisfactory, please review your expenses allocation or revenue forecast. Companies often make net profits of 5% to 10%, while some companies can make as much as 30% higher depending on the industry.
5. Allocate resources based on your financial strategy
Distribute resources based on business goals and avoid converting resources into non-critical territory. For example, if you focus on expanding your customer base, you allocate more money for marketing and customer acquisition.
6. Explaining unexpected costs
Unexpected costs should rise while running your business, such as equipment repairs, office maintenance, or the need for more raw materials to fill large orders. To explain these minor or major emergencies, leave your budget room or even dedicate a line item to your budget.
Similarly, future expenses can be added to your budget. That way, you won’t be surprised at the cost when it comes to it, such as purchasing new equipment.
7. Monitor and adjust
As a financial roadmap for the upcoming period, the budget is a living document that requires regular updates. Your business environment is constantly changing, and sometimes unexpected circumstances can affect your revenue and costs. Browse your budget monthly or quarterly to compare your actual income with your forecast. If necessary, adjust to reflect changes in the business environment.
The relationship between cash flow and profitability
Cash is king, so monitoring your cash flow is important. Cash flows are reported in the statement of cash flows, a financial statement that tracks how cash goes out of business during a particular period.
Although positive cash flow and profit are not the same, both are important. The business may be profitable, but may have negative cash flow. For example, generating revenue doesn’t mean that cash will increase immediately. Sometimes businesses make sales but do not receive payments for another 60 days. The cash flow statement will not reflect these funds until it lands in your business bank account.
Similarly, paying for expenses does not necessarily affect your cash reserves anytime soon. If you purchase the equipment but don’t need to pay it immediately, the money will not be reflected in your cash flow statement until you leave your account.
While profit is a measure of overall survival, cash flow is an indicator of liquidity. Cash is required for the company to survive for a short period of time. However, profitability is essential in the long term. If the business fails to achieve profitability, it will ultimately translate into a cash flow issue.
Benefits of creating a business budget
Budgeting for your business is more than just a financial exercise. It is a strategic tool that can drive your business towards success. Creating a business budget offers several business benefits.
- Improved financial management: A budget can help you clarify your business’s finances and help you stay within the scope of your means when new opportunities and costs arise.
- Setting financial goals: Budgeting your business will help you develop strategic short- and long-term goals and move your business forward, knowing how much revenue you need to achieve these goals. It also helps you know what to do with additional funds when your business is profitable.
- Enhance your decision-making: Budgets provide the data you need to make informed financial decisions, such as prioritizing your investments, identifying areas to reduce costs, or planning your business’s growth. It helps effectively prioritize the right projects and focus areas.
- Better Funding Opportunities: Whether you are applying for a bank loan or looking for an outside investor, you will need a financial plan to get the funds. Lenders and investors assess current, past and projected financial performance when deciding whether to provide funding.
- Risk Reduction: As part of your business budget, you will want to establish a Small Business Emergency Fund. This emergency fund will help you survive the financial storm if something changes in your market. You can continue to fund your business operations until you understand how to overcome market challenges.
- Increased accountability: The budget sets clear financial goals and ensures that all teams line up with business goals. You can also see how closely the forecasts for actual revenue and spending are compared to the company’s actual financial performance.
Key features of a successful business budget
Bad planning can lead to differences in business budgets and their true performance. To make your budget more effective and accurately, make sure to include the following features:
Realistic predictions
Budget is as effective as the accuracy of that assumption.
An effective budget starts with analyzing historical data and incorporating current market research to make realistic assumptions about future performance. Startups with no previous financial track record can use industry benchmarks and market research to derive estimates.
Appropriately classified items
Break down expenses and income into specific categories such as operating expenses, marketing expenses, and sales revenue. This level of detail ensures accurate calculations of different types of profits and makes it more clear about financial performance.
Matches with setting financial goals
Your budget should reflect the strategic goals of your business. Define strategic objectives, identify projects that drive progress towards each goal, and rank them based on their potential impact, costs and potential risk. Allocate resources to regions and projects that support sustainable growth.
Conclusion
Creating a business budget is important for financial stability and long-term success. Start by evaluating your financial history, predicting realistic revenue, and classifying expenses. Regular monitoring and coordination can help you ensure that your budget is a reliable guide to informed business decisions.
