Ah, that dreaded “B” word: Budget. It sends many small business owners running for the hills. In fact, in 2021 nearly half of small businesses did not have a business budget. When you think of writing a business budget, you might associate the process with lost time, counting money, and Excel-induced headaches. Who really sticks to a budget anyway, right?
The reality is that every small business owner needs to understand the basics of business budgeting. Even if you use a financial manager or accountant, smart budgeting will help you operate efficiently. It is a crucial small business management tool. In this guide, we’ll simplify the process of writing a small business budget by covering the following:
A small business budget delivers five key business capabilities:
Budget planning and management techniques help you identify areas to focus your spend. On the other hand, tying goals to your budget can show you where you need to conserve cash. In general, it helps you predict how much cash you need to sustain planned monthly operations. This capability is critical to the long term viability of your company.
The general idea of a budget is that every dollar of sales should be accounted for somewhere in your business. A budget holds owners, business managers, and employees accountable for spending appropriately. More specifically, it helps ensure spending is driving results related to business goals.
A budget review and analysis (more on this later) can reveal hidden problems in your business as well as opportunities for growth. Ultimately, it provides clarity on your business’s overall financial health.
Without a budget you have no measuring stick by which to evaluate your business results and performance. A small business budget helps you set performance targets, such as increasing customers or implementing efficient processes. It forces budget owners to outline a plan to arrive at results. Budgets also provide a basis of performance comparison by recording business results over time.
The development of your small business budget ensures that you consider all aspects of your business—strategic, financial, operational—and that they work together to deliver the overall budget.
The good thing about budgeting is that it’s fairly straightforward after you’ve done it a couple of times. So, what’s the first step in creating a budget? Let’s look at how to get started and how to create a repeatable process.
When executed correctly, the following steps will deliver a strong framework for business spending that drives results.
Without question, the first step of creating a budget is knowing where your business stands financially. In addition to your P&L, you need a handle on other financial data. What are your average order sizes and payroll costs? What are you spending on materials? How much do you owe from borrowing? If you have team members managing these areas of your business, get aligned with them. Better yet, may we suggest free technology that tracks and categorizes income and expenses?
It is important to ensure that spending is tied to specific and realistic business goals when preparing a budget. The primary goal, of course, is profitability. But there are a number of other business goals that ladder up to profit—all of which can be supported through a business budget. For example, if your goal is to increase sales, you may need to budget for more salespeople. If you need more leads, you’ll need a marketing budget for headcount or advertising. But this is critical—set numbers to these targets. How many leads? How many new customers? Your budget allocations and performance evaluations depend on specific targets.
Many people think that a budget is all about expenses, but that’s not true! A budget starts with revenue because that number is what tells you how much you can spend. You can use the average revenue over the last 3 years or the number of products ordered each month as a basis for calculating revenue, adjusted for anomalies and significant business changes. Then, given your current knowledge of your market, customers, sales trends, timing of receipts, plans for growth and so forth, forecast any expected changes to your revenue. Be sure to include all sources of funds.
Overheads and subscriptions, advertising and marketing, administrative salaries, and so forth are all part of operating expenses. Don’t forget to account for taxes of all kinds in your budget! If you don’t know exactly how much tax you’ll owe, a good rule of thumb is to add 30% of operating income.
Overheads and subscriptions, advertising and marketing, administrative salaries, and so forth are all part of operating expenses. Don’t forget to account for taxes of all kinds in your budget! If you don’t know exactly how much tax you’ll owe, a good rule of thumb is to add 30% of operating income.
Add all these items up and you will have your initial budget (basically a P&L) for the period. But you are not done yet!
Make sure that your financial goals are supported by your drafted budget. If there are no gaps or overspends, you’re good to go. In case your financial goals and your budget do not align, go back to the drawing board and make realistic adjustments.
A budget has no weight if it hasn’t been reviewed for soundness and approved by those responsible for its development and execution. Typically this would be a business owner, along with a board of advisors, financial manager or other senior managers. If you’re self-employed, it may be worth using a consultant or trusted peer.
Once you create your budget, it won’t be the last time you do so. You should do this monthly, quarterly and annually. So save it, evaluate it, and adjust based on your business’s performance in all the areas you budgeted for.
There are different approaches to creating and managing your small business budget. Here are three common ways:
Incremental budgeting takes actual historical income and expense category results and adds a percentage increase or decrease to determine a current year budget number. This simple form of budgeting is easily executed by small businesses and is fine if your business does not normally experience a change in key income and cost drivers. The downside to this type of budgeting is it tends to ignore external factors and can result in less understanding and management of actual budget drivers.
In this approach, every department or function is assigned a budget of (you guessed it!) zero. Each department creates its own budget from scratch and in the process must justify the addition of each of its costs to the overall budget. The goal is to avoid any expenses that are not absolutely necessary to the business’s success. These individual budgets are then “rolled up” into an overarching budget that is reviewed and adjusted by management. The downside to this approach is that it is time-consuming. The benefit however is that it is probably a more realistic budget due to the “bottom up” nature.
These first two types of budgeting are the most common, especially for small businesses. However there is one more approach to be aware of.
This type of budgeting starts with an analysis of business activities and the associated costs that support high level business targets set by management. These budget targets are then allocated in a “top down” fashion to various parts of the business for implementation. This approach is more rigorous than incremental budgeting because it scrutinizes the costs that go into each business activity. However it is time consuming and may not be appropriate for certain types of businesses.
Now that you understand a smart budgeting approach, it’s time to start plugging in numbers! Getting started with budgeting numbers for your business can be challenging if you are one of the 50% of business owners who have not created a budget. To help get you started, we’ve created a small business budget template that you can download, customize, and print. This template can serve as a great first step toward a more in-depth budget for your business.
Alright, you have templates. You have a step-by-step plan to get started. Here’s one more set of resources to help you budgeting process go as smoothly as possible. Keep these tips in mind as you budget for your small business.
When it comes to writing a business budget, the devil is in the (lack of) detail. While it’s tempting to stick to high-level forecasts and ballpark numbers, you’ll get the most benefit from specific, line-by-line budgeting. It is critical to create a detailed budget whose line items are rooted research, trends, and targeted activities. This will help you identify opportunities and problems during the budget period. It will also ensure team members truly understand the correlation between spending and desired outcomes.
After you create an initial budget, you should find a way to track spending in real time. By understanding what you spend money on and how much you spend, you can see exactly where your cash is going and areas where you can cut back and make better business decisions.
Many business owners still input expenses line-by-line into spreadsheets. There’s nothing wrong with that, but there’s free technology that will save time and remove the possibility of human error. Find an app that tracks (and even categorizes) every expense from your budget. Now, you can get insights and trends to help manage the budget and to plan for the future. An added bonus of budgeting software is they help eliminate manual and mathematical errors that can wreak havoc on future budget-related decisions.
In budgeting, the output depends on the input. One goal of the business budgeting process is to align different areas of your business toward common goals. With that in mind, you need to understand the requirements and goals of each department.
As the leader of the business, you can help each department commit to goals that contribute toward profitability. That will help each manager budget toward individual goals. It also drives accountability for spending and progress.
Analyzing business performance and results against the budget is a critical part of smart budgeting. Focus on variances—differences between the budgeted and actual amounts. You can find variances in spending, but you can also find them in output. If an investment in a marketing campaign came with a goal for leads, report on the progress regularly. When you find variances in spending or results, revise the budget and optimize.
Other budget performance management measures include tracking and maintaining certain financial management ratios such as time to breakeven or liquidity ratios.
The COVID-19 pandemic was a painful reminder to build contingencies into a budget. Doing so helps to enable your business weather big storms and unforeseen events. If a piece of equipment fails, or if supply chain issues disrupt your cash flow, you’ll need to adjust.
While it’s impossible to predict a pandemic, it is possible to prepare for adjustments to your budget. Can’t find wiggle room in your budget for worst case scenarios? Ignore this at your peril! You may need to go back to the drawing board and re-examine your 10 budget steps.
Creating a budget is not a one-and-done process. Your business goals and circumstances may change over time. You may overspend dramatically one month. Seasonality and trends may impact results. A large customer could default, or you could gain a new large customer. These changes need to be reflected in your future budget. The budget should be a living document that provides a solid reference for decision making and strategy.
It’s a good idea to establish a formal review process for comparing budget to actual results. A good rule of thumb for ensuring budget adaptations is to hold quarterly budget meeting with managers to review and make adjustments as needed. At a minimum this should occur annually. Doing so will help you optimize your budget over time and make it an even more valuable financial planning tool.
The majority of businesses stay within budgetary limits. In fact, only about one-third of small businesses exceed their budgets. This is great news assuming their budgeting process is sound. It’s important to remember that budgets are not meant to be broken. Emergencies happen and plans change, but if you continuously ignore the plan, it has no real value.
Create checkpoints that require approval to exceed monthly spend limits. A great way to accomplish this is with business credit cards. You can create spending limits and even assign them for specific projects or vendors.
In addition to monthly, quarterly, or annual meetings, it’s a good idea to generate automatic reports. This encourages periodic communication about the budget and how it’s contributing to goals. Ultimately, communication and transparency will help all budget owners stay on track toward their goals.
Smart small business budgeting requires a systematic financial review, future planning and a goal-setting process. While it is time-consuming, it leads to many business benefits. A budget can help you and your managers make informed decisions, track performance, and achieve business objectives. Budgets ensure that spending is tied to realistic goals that ensure long term viability.
With proper budgeting techniques, in the worst case scenario you’ll be prepared for unforeseen events. You’ll also be prepared to course correct if spending is not leading to results. In the best case scenario, you’ll be positioned for a boom in business and future growth opportunities.
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