How to create a business budget

A business budget is the foundation of financial success for any company, large or small. As a financial plan outlining projected income and expenses over a certain period, it provides businesses with a clear framework for managing resources and making informed financial decisions.

Whether you’re just starting or scaling your business, understanding how to create a budget is essential for financial success.

Let’s explore the basics of budgeting for small businesses, its benefits and key features, and actionable steps you can take to create and maintain a business budget that works.

Why is a business budget important?

A well-developed budget allows small business owners to estimate their revenue and expenses, allocate funds for priorities, plan for profitability and remain financially resilient by staying prepared for unexpected financial challenges.

Budgeting is essential for small businesses because it provides financial clarity and helps avoid common mistakes like overspending or underestimating costs. But more than a mere number crunching, budgeting is also a strategic process because it involves setting goals and allocating the resources required to achieve them.

Budgeting basics for small businesses

A business budget is a financial blueprint that provides a detailed plan of your business’s income and expenses during a specific period, typically a month, quarter or year.

While budgets can take various forms, all effective business budgets include a few key components.

Revenue

Revenue is the total income your business expects to generate from selling goods or services. Estimated revenue is calculated by forecasting sales and subtracting the estimated cost of goods sold (COGS) or services rendered.

An established business develops its revenue forecast based on past performance adjusted to account for recent market developments. In contrast, if you’re starting your business, you must rely on industry benchmarks or compare data from similar companies in your niche to build a realistic projection.

Avoiding overly optimistic projections when estimating revenue is essential — overestimating can lead to unrealistic spending plans.

Fixed costs

These costs remain constant over time, regardless of the scale of your production or any other business activity. For instance, rent is a fixed cost — it doesn’t fluctuate based on how much your business produces in a given month.

It’s essential to include fixed costs in the budget as it indicates the minimum revenue your business needs to earn to cover costs that will occur regardless of your business activity.

Variable costs

These are costs that fluctuate with business activity. For example, the cost of raw materials will increase if you produce more goods.

The simplest way to forecast variable costs is by using historical data. Begin by taking the total variable cost from the previous year and dividing it by the number of units produced during that period to calculate the average variable cost per unit. You can then multiply this number by the projected sales for the upcoming period to estimate your total variable costs.

One-off costs

One-off costs are non-recurring expenses that don’t fall under usual business activities. These may include one-time software or equipment purchases, for instance.

While recurring expenses are generally easier to forecast, one-time expenses are more difficult to predict. Here, it helps to align your budget with your procurement plans. For example, if you expect significant expenses next year, such as purchasing office equipment or software, be sure to account for these as one-time expenses in your budget.

Profit

Profit (net income) represents the difference between revenue and total expenses, reflecting your business’s profitability. It is reported in the income statement, also known as the profit and loss (P&L) statement.

Every business needs to track several types of profit:

• Gross profit is defined as revenue minus variable costs, such as the cost of goods sold.
• Operating profit — also known as earnings before interest and tax (EBIT) — includes only the net income a business generates from its regular business operations.
• Net profit — the bottom line or the final profit figure after all expenses have been deducted from total revenues.

The relationship between cash flow and profitability

Cash is king, which is why monitoring cash flow is critical. Cash flow is reported in the cash flow statement, a financial document that tracks how cash moves into and out of business during a specified period.

Positive cash flow and profit are not the same, yet both are important. A business may be profitable yet have negative cash flow. For example, generating revenue does not always increase cash immediately. Sometimes, companies make a sale but do not receive payment for another 60 days. The cash flow statement won’t reflect these funds until they land in your business bank account.

Similarly, incurring an expense does not always impact cash reserves immediately. If you purchase a piece of equipment but do not have to pay for it immediately, it won’t be reflected in your cash flow statement until the money leaves your account.

While profit is a measure of overall viability, cash flow is more of an indication of liquidity. Cash is required for the company’s short-term survival. However, in the long run, profitability is essential. If a business can’t achieve profitability, it will eventually translate to cash flow problems.

Benefits of creating a business budget

Budgeting isn’t just a financial exercise; it’s a strategic tool that can drive your business toward success. Creating and reviewing a budget offers several business benefits.

Improved financial management

A budget helps you gain more clarity about your income and expenses, ensuring you stay within your financial means and allowing you to have better control of cash flow and avoid unnecessary debt.

Strategic goal setting

Budgeting isn’t just about costs and allocating spending; it’s also about defining company goals and determining how much revenue is required to reach them. Involving your team in the budgeting process encourages collaboration and reduces resistance to change.

Enhanced decision-making

The primary objective of budgeting is to ensure a business has enough resources to meet its goals. A budget gives you the data needed to make informed financial decisions, whether prioritizing investments, identifying areas to cut costs or planning for growth.

Since resources are always limited, difficult decisions need to be made. A budget brings the clarity needed to effectively prioritize projects and allocate funds where they will have the greatest impact. When setting priorities, every business needs to consider the return on investment for each project.

Better funding opportunities

Whether you’re applying for a bank loan or seeking an outside investor, you will need a financial plan to get funding. Lenders and investors evaluate current, past and projected financial performance when deciding whether to provide financing.

Risk mitigation

Budgets prepare your business for unexpected challenges like economic downturns or sudden cost increases. Contingency funds are money businesses set aside to account for unforeseen expenses. They act as a buffer ensuring that the business can continue operations without diverting resources from other critical areas or taking on debt.

Improved accountability

Budgets set clear financial targets, ensuring every team stays aligned with company objectives. They can also be compared to the company’s actual financial performance to see how close predictions were to real revenue and spending.

Key features of a successful business budget

Poor planning can lead to differences between a business’s budget and its true performance. To budget more effectively and accurately, be sure to include the following features.

Realistic projections

A budget is only as effective as the accuracy of its assumptions.

Effective budgeting starts by analyzing historical data and incorporating current market research to make realistic assumptions about future performance. Startups without a prior financial track record can use industry benchmarks and market research to guide their estimates.

Adequately categorized items

Break down expenses and income into specific categories, such as operational costs, marketing expenses and sales revenue. This level of detail ensures accurate calculations of various types of profit and provides greater clarity about your financial performance.

Alignment with business goals

Your budget should reflect the strategic objectives of your business. Define your strategic objectives, then identify the projects that will drive progress toward each goal and rank them based on their potential impact, cost and potential risks. Allocate resources to areas and projects that support sustainable growth.

7 steps to create a business budget

Creating a business budget is an essential process for ensuring financial stability. Here’s a step-by-step guide to help you create an effective budget.

1. Review past financial performance

Analyze your financial documents, including income statements, balance sheets and cash flow statements, to identify trends and better understand your revenue and expense patterns.

2. Forecast revenue

Estimate how much income your business will generate during the budgeting period. Be conservative to avoid overestimating your revenue. New businesses should research industry averages and benchmarks to estimate your revenue.

3. Identify fixed and variable expenses

Categorize your costs into fixed and variable. Understanding these distinctions helps in allocating funds more effectively. Include irregular expenses, such as new equipment purchases or attending a trade show, to avoid surprises and ensure you’re prepared for larger financial outlays.

4. Set profit goals

Determine how much profit you want to make during the budget period. Subtract your estimated expenses from your projected revenue. If the result isn’t satisfactory, revisit your expense allocations or revenue projections.

5. Allocate resources

Distribute resources based on your business’s priorities to avoid over-allocating resources to non-critical areas. For example, if you focus on growing your customer base, allocate more funds to marketing and customer acquisition.

6. Monitor and adjust

As a financial roadmap for the upcoming period, your budget is a living document that requires regular updates. The business landscape constantly changes, and sometimes unforeseen circumstances impact your revenue or costs.

Review your budget monthly or quarterly to compare actual performance against projections. Adjust as needed to reflect changes in your business environment.

The bottom line

Creating and maintaining a business budget is critical for financial stability and long-term success. Start by evaluating your financial history, forecasting realistic revenue and categorizing your expenses. Regular monitoring and adjustments will help ensure your budget is a reliable guide for making informed business decisions.

Frequently asked questions

How do I create a business budget for a new business?

If you’re launching a new business, use market research and industry benchmarks to estimate revenue and expenses. Adjust your budget as your business generates data over time.

How often should I update my budget?

Update your budget monthly or quarterly to account for changes in revenue, expenses or market conditions.