If you’re just launching a small business, it’s likely that budgeting is close to the last thing you want to think about during such an exciting time. However, failure to create a well-designed budget in the early days of your company’s life can have serious consequences.
The No. 1 reason small businesses fail is that they don’t structure their finances correctly. Without a keen eye on how much money comes into the company versus how much goes out, few small business owners can adequately plan for the day-to-day funding demands. Business owners without a carefully placed budget can quickly get bowled over by unexpected expenses.
The good news is that small business budgets don’t have to be complex or daunting. In formulating a budget for your small business, you can save yourself the stress and bolster your business’s health. Here, we’ll break down the best way to create a budget for your small business in easy, understandable terms.
Why Budgets Are Important for Small Businesses
No matter your business or how you envision running it, a budget can help you reach your goals faster while keeping you focused on the impactful money matters of today.
Here are a few key reasons it’s so important to design a working budget when starting a business along with examples of how budgets can play out in real-world business scenarios.
Budgets Speed Up Decision-Making
Let’s say you plan to open a microbusiness in construction, and you’re not sure if your website is up to scratch with those of competitors. Can you afford a digital renovation right now? If designed insightfully from the beginning, your budget can answer that kind of question for you.
The alternative is crunching numbers each time you need to know what your small business can afford or swiping your business credit card now and worrying about the consequences later. Without a budget, your construction company may not be able to afford the supplies or materials needed to take on the next job — an awful surprise when you need to generate income.
Budgets Allow You to Plan for Contingencies
Living paycheck to paycheck is not advisable for any business. The small business universe is volatile, unpredictable, and ever-changing. Your budget should function as a tool, allowing you greater control over circumstances that can decide so much of your company’s success.
For example, say you are thinking of basing a small freelance business around two to three big clients. You know the kind of capital these clients bring in, and you know how to delegate that cash flow effectively. However, have you thought about how long your business can realistically survive if one or more of those key clients decides to take a better offer elsewhere?
Situations like this arise every day for small businesses, and a budget can help you plan accordingly, keeping you going the way you planned even in the absence of important players.
Budgets Allow You to Identify Helpful and Harmful Trends
It’s hard to fix what you don’t know is broken. A smart budget does more than show you the funding you have today and project what you might have tomorrow. It allows you to look back at all the funding you’ve had and examine the entire fiscal history of your small business.
By examining income sources and profit margins, you can see quarters that were particularly profitable and recognize why those quarters were so successful. You can also inspect low points in your revenue stream and use that information to make valuable changes. Looking back on performance and budget can help keep small businesses informed and adjust future choices and goals relating to your company’s financial well-being.
How to Create a Small Business Budget
Let’s look at some actionable takeaways and real-world examples regarding the creation and use of a budget in your small business. In four steps, you’ll learn what’s necessary to include in your small business budget and how to tailor it to your company’s unique needs.
Four steps to creating a budget for your small business:
- Calculate the money coming in
- Calculate the money going out
- Fixed costs
- Variable costs
- One-time costs and emergency expenses
- Calculate your net income
- Set financial goals for your business
Step 1: Calculate the money coming in
One of the best parts of small business ownership is seeing a lifelong dream turn into dollars before your eyes. Totaling your revenue streams in a timely and established fashion is the first step to forging a workable budget.
Start the business budgeting process by identifying each place from which your business pulls in income. Most businesses enjoy revenue from more than one stream. A few examples of common revenue streams include:
- E-commerce (such as sales on your website)
- Brick-and-mortar sales
- Government grants or stipends
The advice here is simple: Calculate the total contributions from each revenue stream feeding into your business each month. How you choose to conduct those calculations can be as unique as your small business.
For instance, maybe your home decor business derives e-commerce funds from two online sources: your website and a social media platform. You may wish to split those streams into individual columns in a spreadsheet or a notebook to monitor sales, or you might decide to combine both with your brick-and-mortar sales because you want to see all revenue from products or services in one column.
Are you already terrified of tallying those digits for your new business? Don’t be! There are plenty of great accounting tools online that do the bookkeeping for you. All you have to do is keep them fed with accurate numbers relating to your small business.
Popular software programs like QuickBooks, Xero, FreeAgent, and Scoro can complete tasks from adding up your total sales for the week to generating balance sheets or reporting taxes. Accounting software is always helpful, but you can also keep up with your business expenses in programs like Microsoft Excel, which offers accounting templates.
You might still be in the stage of writing your first business plan, wondering how to formulate a budget on the money you’ve not yet made. Microbusiness owners who haven’t earned their first dollar yet need a strong budget plan because it represents not just the chance to launch your startup right but to take real steps toward big financial goals. Generate your budget plan by making conservative estimates on the money you’ll bring in based on the prices you plan to charge for your goods or services, industry-standard costs, and competitor trends. Make sure these figures gel with what you have written in your business plan and leave a wide margin for unforeseen expenses. Of course, you can always adjust your budget and figures as the real numbers come in, but it’s important to start somewhere.
Step 2: Calculate the money going out
Everybody knows that running a small business is tough and never cheap. Planning wisely for expenses is crucial to your success because it shows where your funds are going and allows you to see where reconfiguration might be needed to help save money.
If your small business is not running yet, calculating your future expenses is going to feel a bit like a mandatory chess game. You have got to think a minimum of five moves ahead. Again, making conservative estimates on what’s going to cost you to run your business can be accomplished via examining industry trends, factoring in market shifts and demographics, and making safe, educated guesses based on the following examples.
Fixed costs don’t change when sales go up or down. Fixed costs are expenses that your business will always face, no matter the state of the market. A good example of a fixed cost that your company will face is the rent, lease, or mortgage on the space/building you utilize to conduct business.
Some expenses listed in your small business budget will increase and decrease in tandem with your company’s sales. Supply and demand will dictate variable costs, such as those associated with raw materials, utilities, and labor. For example, if you own a small sheet metal company and get hired to fabricate pieces for a new subdivision development, you will need to factor in the major uptick in funding necessary to cover the metal and materials required to complete the project.
One-Time Costs and Emergency Expenses
Arguably, the most tricky aspect of your small business budget to plan for are one-time and emergency expenses. These are the expenses that exist outside of normal operating costs and are not expected to recur with any degree of frequency in a business’s life span.
Examples of one-time expenses might include the cost of relocation or the installation of the necessary equipment in the workspace. For example, if you are converting your loft into a space to run your new coffee shop, it’s unlikely you will have to pay for wiring and unique kitchen plumbing more than once unless you choose to move your business. These would be categorized as one-time expenses.
Emergency expenses are the sort you hope not to need but must always plan to have. You never know what problems or unexpected challenges may present in the formation of a small business. Examples of emergency expenses can include anything from equipment repair to storm damage not covered by insurance.
Step 3: Calculate your net income
Figuring out your business’s net income is just a matter of subtracting the total outgoing costs from the total incoming money. That number lets you know if your small business is currently at a profit or a loss. The following calculation illustrates how a determination of net income might look for a freelance graphic designer once the budget details are put together:
- Client 1 hourly earnings: $3,000
- Client 2 hourly earnings: $2,800
- Product sales: $550
- Savings: $2,000
- Investment returns: $300
Total Income: $8,650
Expenses (fixed costs):
- Mortgage: $950
- Payroll: $2,500
- Insurance: $60
- Wi-Fi: $45
- Website hosting: $25
- Telephone: $50
- Accounting services: $85
- Legal services: $100
Total Fixed Costs: $3,815
- Electricity bill: $650
- Gas bill: $280
- Water bill: $125
- Contractor wages: $500
- Transportation: $65
- Raw materials: $400
- Digital advertising: $350
Total Variable Expenses: $2,370
- Office supplies: $250
- Office furniture: $550
- Project management software: $300
- Client gifts: $75
Total One-Time Expenses: $1,175
Total Expenses: $7,360
Total Income ($8,650) – Total Expenses ($7,360) = Total Net Income ($1,290)
From this breakdown, you can see the value in listing each expense for your small business. Even if you haven’t yet generated a penny and are still just floating ideas in your head, take the time to itemize the costs associated with your ideas, down to the tiniest detail. Insert educated estimates in slots for which you don’t currently have live information and base these estimates on findings for equivalent small businesses within your industry and other research.
You shouldn’t wait until you have fully launched your small business idea before getting into the nitty-gritty of your budgeting plans. At the very least, formulate a business budget template so you can see place holders for future expenses and have a clear picture of expenses associated with your business needs.
This step can help you know whether a business loan is a good idea and what amount of money you should borrow if so. We can’t emphasize this enough: Taking the time to create a balance sheet now will prevent you from common, costly mistakes once real money is involved.
Step 4: Set financial goals for your business
The fourth and final step to creating a budget for your small business is to take your calculations of net income (see step 3) and use them in actively setting financial goals. This is a crucial step, whether your business is “in the red” (at a loss) or “in the black” (at a profit) currently.
If you find that you have come to the end of a short month, and your business is in the red, don’t let that number get you down — instead, set an attainable goal for improvement. Take a look at whether this deficit was caused by factors you can adjust within your variable expenses, such as transportation costs.
Taking the train or setting up an office carpool might boost your numbers next month. Likewise, if your budget shows that your business has turned a profit for the month in question, it’s not time to splurge! Earmark that surplus for a future fiscal benchmark by investing it or using it to pay down a fixed cost, like the business mortgage.
If you are completing this step before you have kicked off your business, you are at an extreme advantage and should use it as such. You have the luxury of toying with the numbers in this section in a way that businesses up and running do not. Use this step as an informative, interactive tool with which to guide and structure your business plan. Remember, the beauty of just starting is that you have a clean slate on which to experiment and set your business up for success.
No matter where you are in the life of your small business, always keep the long game in mind when examining your budget. How can this profit best be used to bolster your company’s five-year goal? Where can you cut corners this year to reduce your overall deficit next year?
Don’t fall into the common trap of setting overambitious goals or no goals, as both hurt your business. Ultimately, the monthly review of your company budget should be a springboard for new ideas, fresh approaches, and reconsiderations aimed at bettering the health of your small business.
Updating and Maintaining a Budget
While no business owner is jumping up and down with glee at the prospect of working through piles of figures, invoices, and percentages, thinking about the cost of not doing so might be the motivation you need to set a budget for your company.
Federal agencies, such as the U.S. Bureau of Labor Statistics (BLS) and the Small Business Association (SBA) report that 20% of small businesses fail within their first year of life, largely due to fiscal mismanagement. Carrying out the steps outlined in this article puts you ahead of the game and sets up your small business for success.
If you find yourself in need of further resources as to the specifics of budgeting, check out ZenBusiness for small business strategies you can use today.