By Kyle Bayliss, Managing Director for the Maryland Small Business Development Center
Published June 22, 2023
Creating a small business budget is essential for any entrepreneur who wants to succeed. A well-planned budget lets you make informed decisions about spending, saving, and investing in your business.
More specifically, a business budget can benefit your company by:
- Making it more efficient.
- Helping you find leftover funds that can be reinvested.
- Predicting slow months and keeping you out of debt.
- Estimating what it will take to become profitable.
- Providing a window into the future.
- Helping you keep control of the business.
Having realistic budgets year after year helps you understand how much money you have and what you’ve spent where—and provides clues about how much money you’ll need in the short and long term. It can also help mitigate unexpected costs and shape critical business decisions, like whether to add staff and equipment or where to cut expenses to avoid cash flow issues.
How about some real-world stats to get you going? A small business budget is particularly important at a time when companies are coping with rising costs–like now. 80 percent of small business owners polled in Bank of America’s 2022 Small Business Owner Report said they are concerned about inflation, and 75 percent said they are worried about commodity prices.
Need some extra motivation to start crunching budget numbers? The number 1 reason small businesses fail is because they don’t structure their finances correctly.
Few small business owners can sufficiently prepare for everyday funding demands without a constant eye on how much money comes into the company compared to how much goes out. Business owners without a budget in place can be quickly overwhelmed by unexpected expenses.
There’s no doubt that having a business budget can keep you ready for the unexpected. The good news is that small business budgets don’t have to be complex or daunting. No deep breathing or meditation is needed. Just read on for some simple tips for getting started with yours.
Here are two of the ways to budget, based on where you are in your business’s life cycle. There are other more complex budgeting methods, but save them for when your business targets $5 million(!) in revenue (Activity-based budgeting) or you have more managers to involve (Participatory budgeting).
Zero-based Budgeting
This budgeting method takes the current period’s budget or actual performance, uses it as a base, and then adjusts it in incremental amounts to account for any cost increases. When you put together an incremental budget, you usually use the inflation rate as a guide for fine-tuning the amounts. One advantage of this way of budgeting is that it is relatively easy to do.
But in case your head is already spinning, let’s forget those methods and their labels for now. To help you get started, I have compiled a simple list of things to consider as you create a small business budget.
1. Identify Your Revenue Streams
Most of the time your budget will cover a 12-month period, and the planning for the next budget period will begin 3-to-6 months ahead.
The first step in creating a budget is to identify your revenue streams. As Nicole Saunders, a financial advisor at NerdWallet, explains: “Revenue is the lifeblood of any business, so it's important to have a clear understanding of where your money is coming from.” This means identifying all sources of income, such as sales, services, and investments.
If your business is already up and running, you can consider taking an additional step after you identify your revenue streams and focus on calculating your revenue. Include all your revenue streams, preferably over at least the last 12 months, to determine your monthly income. If your business is new, you can research what’s typical in your industry and use that as a guide to come up with estimates.
2. Determine Your Fixed and Variable Expenses
Once you have identified your revenue streams, the next step is to determine your fixed vs. variable expenses. Fixed costs, such as rent, salaries, insurance, debt, and loan repayment, remain constant.
As the name implies, variable expenses, such as marketing and materials, fluctuate based on sales or production levels. Variable costs can also include billable labor, transaction fees and commissions.
As you move farther along in the life cycle of your business, you can learn more by subtracting your fixed and variable costs from your income. This determines what it costs to produce your product or service. Any change in costs affects your net income—how much the business makes after subtracting all expenses, the cost of producing your product or service, and taxes. The amount left over is money you can use to invest in business growth.
3. Allocate Funds for Unexpected Expenses
It's important to have an emergency fund for unexpected expenses, such as equipment breakdowns, legal fees, or emergency repairs. As financial advisor Eric Roberge advises: “The last thing you want is to be caught off guard by an unexpected expense that derails your budget.” Allocating funds for unexpected expenses ensures you have a cushion to fall back on in emergencies. It’s a good idea to set aside this just-in-case fund for unforeseen costs like replacing equipment sooner than planned.
4. Plan for Growth
5. Revisit and Revise Your Budget Regularly
6. Learning from your Profit and Loss Statement
7. Using your Budget to Make Better Decisions
You did it! You have a budget in place and are no longer guessing what it will take to make your business successful. You may be inclined to hit “save” and file your new budget away for future reference, so you can get back to the fun parts of your business. Resist that urge! If you keep your budget on your daily radar and refer to it as a regular resource, you’ll be rewarded for your efforts.
As you make spending decisions, consult your budget frequently and use it as a reality check. If you go beyond an amount your budget dictates, you’ll have some explaining to do to yourself, or at some point presumably, other stakeholders in your growing company. Being disciplined from the start can be challenging, but ultimately it will position your business for growth, today, tomorrow and far into the future.
8. Using Budgeting Tools and Software to Stay on Track
In addition to seeking professional guidance and resources regarding money matters, there are many options for taking control by using budgeting tools and accounting software. Here are a few resources to help you get started:
Down the road, your budget will help you set your expectations and make clear to employees what resources are available to them to get their jobs done. It will also provide a measuring stick for tracking business growth and serve as an indicator of your company’s financial health. Every business needs a budget to be successful, and it starts with setting one that reflects the reality of your business expenses.
The bottom line? Creating a small business budget is crucial for success. Creating a realistic budget and revisiting it regularly allows you to make informed decisions about spending, saving and investing in your business. A budget is the foundation of financial success, so take the time to create a solid one for your small business.
Sources
https://www.nerdwallet.com/article/small-business/how-to-create-a-business-budget
https://www.bankofamerica.com/smallbusiness/resources/post/don-t-fear-the-b-word-how-budgets-can-liberate-your-business/
https://getjobber.com/academy/small-business-budget/
https://www.zenbusiness.com/small-business-budget/