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Every small business owner wants their organization to be a success. However, 82% of small businesses fail due to cash flow problems, pricing, and/or cost issues highlighting the importance of proper business budget planning.
A comprehensive business budget is the best way to avoid these issues and support your revenue growth. It helps you identify how best to use your funds to meet your business goals both in the long and short term.
In this guide, we’ll break down what a business budget is as well as how to build a budget for your small business with one of our helpful (and free) business budget templates.
What is a business budget?
A business budget is an essential process that allows you to view your financial resources at a glance helping you to project profits, losses, and overall financial health. It consolidates all your essential financial information including income, expenses, and other variable costs, letting you pinpoint areas that need improvement.
Every business should maintain an annual budget that can be broken down into monthly or quarterly segments. You can also create a business budget for specific events and times of year to help you manage seasonal business and one-time expenses. This allows for more detailed financial monitoring during busy periods.
When creating a budget you need to keep accurate records of outgoing expenses including:
- Fixed expenses: such as employee salaries, rent, bank fees, and loan repayments.
- Variable expenses: costs like supplies and utilities that fluctuate monthly.
- Ad hoc expenses: one-time costs, such as purchasing new equipment or covering repair costs.
Your business budget also needs to outline expected income.
Why do I need a small business budget?
Every organization needs a clear understanding of their business finances and operating expenses. A comprehensive budget demonstrates your ability to manage finances and plan for future expenses, like loan repayments, to help build a financial plan.
This can increase confidence among lenders and investors regarding your business’s prospects. Knowing your income and anticipated expenditures helps you estimate your annual profits or losses and make informed decisions accordingly.
Evaluate your business strategy
Your budget is a vital tool for evaluating your business strategy, offering insights into what’s working well and where improvements are needed. By creating and analyzing your budget, you can identify successful areas to expand and pinpoint challenges that require your attention and resources.
To make your budget effective, it’s crucial to be both accurate and realistic. Overestimating income or underestimating expenses will lead to financial shortcomings and unexpected losses. A balanced, honest budget helps you anticipate challenges, seize growth opportunities, and maintain a clear view of your business’s financial health.
Planning ahead
Understanding your business budget helps you anticipate where your business is heading financially, leading to better future business decisions. A budget helps you plan for unexpected costs so you can prioritize and implement changes, limiting the negative impact on your business.
Forward planning enables you to identify cost-saving techniques and opportunities for growth. So remember to consider outside factors, such as market evolution, new competitors, and fluctuations in demand. These factors can influence your business’s finances, but a well-thought-out budget can help you adapt.
Business growth
A detailed business budget is essential when applying for business loans or investments. Without it, lenders may have misgivings about your company’s financial health and cash flow budget. A small business budget distills confidence in your ability to repay the loan both on time and in full.
A strong track record of reliable and detailed budgeting shows lenders and investors that you have the ability to develop a business plan and execute it effectively. Stakeholders need to closely examine your financial history first to be sure they’re getting a good return on investment.
How to create a business budget
As your organization grows, you may need to implement different types of business budgets, such as:
- Master budgets: A comprehensive budget that consolidates all other budgets.
- Operating budgets: Focuses on the ongoing costs of running the business.
- Cash-flow budgets: Monitors the timing of cash inflows and outflows to ensure sufficient funds are available to cover expenses.
- Labor budgets: Tracks the costs associated with employing staff.
While each type of budget tracks different expenses, the process of creating a business budget is relatively simple and follows the same step-by-step process.
Predict your business costs
The first step to take when creating a budget is to list your predicted expenses. This includes both fixed and variable costs associated with business expenses like rent, debt repayment, and the cost of raw materials for products. To make things simple, break these costs down into specific expense categories, this helps you identify and track your biggest financial commitments.
You should also consider potential one-off expenses, like purchasing new equipment or upgrading tools. Think about potential future expenses like marketing campaigns and factor these costs into your budget early on. This ensures that you have the funds you need when you need them.
For example, paid advertising on social media might seem optional at first, but this can become a crucial part of your marketing strategy as your business grows. While specific costs will vary depending on your business, a thorough and realistic budget will help you plan for both expected and unforeseen expenses.
Negotiate with suppliers
This step is particularly valuable for businesses that rely on multiple suppliers for their products and distribution. Before finalizing your annual budget, consider negotiating with your suppliers to secure discounted rates for any raw materials, products, or services you need.
Building strong relationships with suppliers through negotiations is especially beneficial when struggling with a low cash budget. For instance, you could offer advance payments when you have sufficient cash reserves, and in return, suppliers might be more lenient about late payments in the future. The key objective is to find effective ways to reduce operating costs and improve financial stability.
Estimate your predicted revenue
When creating a business budget you need to estimate your projected revenue based on your income. You can calculate this by multiplying your predicted number of sales by the price of each product or service. Existing businesses can base these predictions on past sales data, but if you’re just starting out, it’s wise to be conservative in your estimates to avoid overspending based on overly optimistic projections. Accurate revenue projections ensure that you can cover your expenses and avoid financial shortfalls, while still allowing room to exceed your expectations as your business grows.
Understand your gross profit margin
Your gross profit and loss statement represents the cash remaining after your business has covered all of its expenses for the year. It offers a clear view of your company’s financial challenges and success, so understanding the metric is crucial.
For example, if your company generated $10,000 from revenue streams but owed more money due to unexpected expenses or an exceeded operating budget then you have poor financial health. This is a sign of bad business performance and can signal trouble for a growing business.
If this is the case for your existing business then you need to identify and eliminate nonessential expenses from your yearly budget. To get a true sense of whether you’re running a financially successful business you should calculate the cost of goods sold (COGS) for all materials and subtract this from your total sales revenue. This insight helps you focus on increasing future revenue while reducing unnecessary costs.
Project cash flow
Cash flow consists of two main components: customer payments and vendor payments. Maintaining a balance between these is essential for sustaining healthy cash flow within your organization.
To help ensure that customers make their payments on time, offer flexible payment terms that can help if they’re experiencing personal finance issues. Despite this flexibility, some customers may not adhere to these terms which can disrupt your cash flow forecast. To avoid this, offer a grace period and establish strict rules around late payments.
Additionally, allow some space for change by first creating a rough budget. Once you understand your liquidity better, you can create a final budget and use this to set aside funds for business essentials. If there is a surplus of cash and you’re exceeding your financial goals, then you can allocate these extra budgets towards business initiatives like professional development or purchasing new equipment.
Consider annual trends
Sales volume can change throughout the year based on seasonal trends, so it’s important to create a budget that factors in these fluctuations in revenue. Seasonal changes in revenue require careful cash management to ensure that your business and budget remain stable during the slower months.
To ensure this, create a master budget that analyzes when your business performs best and try to generate enough revenue during peak season to keep things running during the slower periods. For example, if you own a summer clothing company, most of your revenue will come during the warmer months. You can use these earnings to keep your business running throughout the year and offer discounts or promotions to generate more sales during the winter.
With this approach, you can better understand your product’s off-season performance, estimate off-season revenue, and determine how much to save during peak periods.
Send spending limits
A budget for your business needs to do more than just calculate your net income and losses, it’s about strategically allocating resources to ensure your business success. The effectiveness of your spending plays a critical role in how your company manages unexpected costs. Setting clear spending goals allows you to evaluate whether your funds are being directed toward the right areas, helping you avoid unnecessary or wasteful expenses.
For example, if you find that money is being spent on supplies or services that aren’t being utilized in your operations, then you need to assess those costs. Regularly reviewing your budget, helps you identify where to cut costs and eliminate these inefficiencies, ensuring that every dollar is contributing to your business’s growth.
Another crucial aspect of smart budgeting is creating a contingency fund. Unforeseen circumstances can result in unexpected expenses, and having a financial cushion can be the difference between overcoming a challenge and facing a crisis. By setting aside a portion of your budget for emergencies, you ensure that your business remains stable even during tough times, allowing you to navigate uncertainties with greater confidence and security.
Try one of our free business budget templates
Now you have all the information you need to create your own business budget. After you’ve subtracted your fixed costs and variable expenses from your projected income you’ll be able to determine how much spending money you have left. This initial calculation gives you an idea of your available funds helping you understand your financial limits and opportunities.
To help you get started, consider using our free small business budgeting template to help you simplify the process. It includes everything that small businesses need to get started managing their budget without having to invest in pricey accounting software. It covers all the basics you need to start tracking your fixed and variable costs and can be altered to fit the specific needs of your business helping you to make informed decisions that align with your business’s needs.
Wrapping up
Creating, managing, and sticking to a business budget is crucial for long-term success. Proper budgeting allows you to effectively allocate resources, anticipate challenges, and make informed decisions that align with your business goals.
You don’t need to invest in top accounting software to get started, by following the steps outlined in this guide, you can establish a solid financial foundation for your business and ensure it remains on track throughout the year.
Key takeaways:
- Creating an accurate budget for your business helps you identify how best to use funds, ensuring your business thrives during both peak and slow periods.
- Strategic spending and regular budget reviews prevent unnecessary expenses and enhance profitability.
- Setting up a contingency fund prepares your business to handle unexpected costs, safeguarding against financial instability.
For more help, download our free small business budgeting template to simplify the process and start managing your finances more effectively.
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Credit: Original article published here.