How to create a small business budget

There’s an old saying, “If you fail to plan, you plan to fail.”

The same rings true when creating a budget for your small business.

And research supports this.

One of the leading causes of small business failure is the underestimation of running costs, according to a study by UK accounting body the Association of Chartered Certified Accountants (ACCA).

Having a budget—and sticking to it—makes your business less likely to underestimate its expenses.

In this article, we explain what a small business budget is, why it’s important, and how to create one.

Here’s what we cover:

What is a small business budget and why is it important?

A budget is a spending plan for your business based on its projected income and expenditure over a certain timeframe, typically a month, quarter or year.

In addition to preventing overspending, here are five reasons why it’s important to have a budget:

1. Budgeting promotes sound financial decision-making

As a small business owner, it’s tempting to rely on your instincts to make judgement calls about your business, such as recruiting.

But it’s best to make financial decisions based on facts and figures rather than intuition. This is where a budget comes in.

2. Budgeting highlights revenue and saving opportunities

A budget will help you identify areas where you can make money and save it.

For instance, it can influence pivotal business decisions, such as whether to recruit staff or trim some of your business expenses.

3. Budgeting provides an overview of your business finances

A budget gives you a bird’s-eye view of how your business is spending and saving over time, and what kind of trajectory it’s on.

It’s also handy if your business is seeking finance. Having a budget gives you a head start on making a loan application or attracting investment.

4. Budgeting assists cash flow management

Nobody likes to face the prospect of a cash flow crunch—least of all small business owners.

A budget sets up your business to distribute its resources efficiently, identify trends and make adjustments, so it doesn’t end up with a cash flow shortage.

5. Budgeting identifies growth challenges and opportunities

For small businesses, growth is good but not all growth is created equal.

It’s all about timing.

Grow too fast, too soon and your business can crash and burn.

A budget enables you to forecast a sustainable pace at which your business can grow. It can also help you spot factors that can make growth a bit more challenging.

What should you include in a small business budget?

The bare bones of a budget should include the following:

Income

Income refers to how much revenue your business expects to generate.

Examples include income from the sale of a product or service and other income, such as investments.

Fixed costs

Fixed costs are incurred on a regular basis, irrespective of how much revenue your business generates.

These include:

• Rent
• Payroll
• Insurance.

Variable costs

Variable costs are the opposite of fixed costs. They’re incurred by your business proportionate to the revenue it generates. As such, they fluctuate monthly. Examples of variable costs include:

• Inventory
• Office supplies
• Commissions.

One-off expenses

One-off expenses are occasional payments your business makes, ranging from minor purchases, such as office supplies, to major ones, such as equipment.

Emergency fund

This is “rainy day” money your business has for unforeseen expenses, such as replacing equipment sooner than expected (you can include this section as part of your one-off expenses).

How to create a small business budget

Now it’s time to create a budget. Here’s six simple steps for you to follow.

1. Assess the financial health of your business

A budget uncovers the financial condition of your business, so you can determine if you need to plough more funds into a certain area or cut back in others.

The first step is to work out if your business is making a profit, a loss or breaking even.

Pull up your business’s financial statements over the past year and look for patterns when its income and expenses are higher or lower, such as at certain times in the year.

If you have access to accounting or bookkeeping software, this process is even quicker and simpler.

2. Set financial targets for your business

Now you’re in the know about the state of your business finances, you can set short term and long-term financial goals that determine how you distribute income to different expense categories.

3. Calculate your business revenue

To work out the average monthly revenue for your business, add up its revenue sources over the past year and divide it by 12.

If you’re just starting out in business, research your industry to find out what revenue is typical and use it as the basis of an estimate.

4. Calculate your business expenses

To calculate the average monthly expenses for your business, add its fixed and variable costs over the past year, then divide it by 12.

5. Determine if your business has a profit or loss

To find out if your business has an operating profit or loss, subtract its fixed and variable costs from its revenue.

The resulting number shows you how much it costs to produce your product or service.

You can use any money left over to invest in growing your business, repay debt, and so on.

6. Allocate your business funds

The final step involves allocating funds for your business based on its financial goals.

To do this, create a budget with the following columns:

• Expenses
• Budget
• Actual
• Difference.

Enter your expenses in the “expenses” column, then distribute a certain amount of your monthly revenue to each expense under the “budget” amount column.

At month end, enter the amounts your business spent on each expense under the “actual” amount column.

Use the “difference” column to enter the amount your business was over or under budget for each expense.

Your business goals can change, so it’s important to review your budget regularly to ensure it’s still fit for purpose.

If your budget is no longer aligned with your business goals, adjust it to reflect changes in revenue, expenses and market conditions.

Who can help with small business budgeting?

If you need assistance creating a budget, there are professionals who can help, including:

• Accountants
• Bookkeepers
• Financial advisors.

In addition to providing a budget template, they can make realistic forecasts about business performance, forthcoming expenses and tax exposure.

They can also advise you on what to do when the actual figures for your business don’t marry up with its predicted numbers.

Final thoughts on business budgets

As a small business owner, drawing up a budget is probably one of the best time investments you can make.

Among other things, a budget allows you to manage your business finances efficiently, allocate its resources prudently and plan for future growth.

But it’s one thing to have a budget and quite another to stick to it.

If your business is committed to its budget, this increases the chances of staying on track towards growth and longevity.

Another key is that your budget isn’t static—it should be changed according to the circumstances prevailing at the time.

Ultimately, your budget should always work for your business, not against it.