December 17, 2021
The Basics of Building a Business Budget
What You’ll Learn:
- What a business budget is and why you need a realistic one
- The basics of budgeting, cash flow, and financial planning
- Tips for building a budget that reflects your business goals
All businesses (from hustling solopreneurs to large corporations) rely on budgets to help guide spending and work toward big picture goals. In basic terms, a budget is a plan that estimates the revenues and expenses of a business over a period of time—typically monthly, quarterly, or annually. If you’re a small business, strong budgeting and financial planning skills are especially important. Here’s why:
According to a study by Jessie Hagen of US Bank, the most common reason small businesses fail is cash flow issues. These issues can stem from a generally poor understanding of cash flow, starting out with too little money, and a lack of a developed business plan and budget. Let’s run through the basics of budgeting for small businesses and sole proprietors, then outline an approach to building your first budget.
What is a business budget?
We already know that a budget is a financial planning document that can help you meet business goals. But what does that mean in practical terms? A budget contains a snapshot of finances today and positions your business to tackle long-term financial growth in an effective way. Want to know how much your business can spend based on incoming revenue and available capital? Your budget will be your guide to smart decision-making. The overall goal of any budget is to make sure more money is coming in than is going out of a business—that way you can keep cash flowing and invest in future growth.
Why are budgets important?
Budgets are an effective way to organize, plan, and track progress toward your financial business goals. If you’re operating a business without a budget you risk losing sight of where your money is going and possibly putting your business in a bad position. Here are some of the benefits of an effective budget:
Make plans: A budget is like a map. If the ultimate destination for a business is profitability and growth, a budget is your guide to getting there—with markers for how to strategically manage incoming and outgoing cash along the way. Use your budget to plan and make spending decisions that will deliver you to your desired destination.
Track progress: Think about where you want to take your business in the short-term and the long-term and how a budget can help you reach each milestone. A short-term goal might be paying off debts or investing in equipment to streamline production. Long-term goals, like expanding to new markets or opening a storefront, are more ambitious but equally important for budget road mapping.
Stay accountable: Budgets are a great way to set expectations and keep your team aligned on big-picture goals. But keep in mind that most financial journeys have detours and pit stops along the way. You will likely need to adjust and update your budget regularly to stay flexible and accommodate new information—and this is especially true for small businesses.
How to create a budget for your business
The good news is that business budgets have been around for a long time, and you don’t have to reinvent the wheel to get started. Use these five easy steps to start your business budget process:
- Measure your revenue
- Calculate overhead costs
- Identify variable expenses
- Plan for fluctuations
- Connect the dots
Now, let’s take a deeper dive into each step.
1. Measure your revenue
Revenue is the money a company receives from its clients, customers, or users. It’s important to note that revenue is not the same as profit! Revenue is all the money that comes into your business before you subtract your costs—once you deduct those expenses, the leftover amount is your profit.
The easiest way to calculate revenue: Number of Sales x Average Price
Another simple formula: Number of Clients x Average Fee
When measuring revenue, you should add up all your income streams to determine how much money comes into your business on a monthly basis. If you’ve been in business for a while, you’ll be able to look at real data to calculate this number—the more data the better! The goal of your business budget is to get an accurate understanding of your yearly revenue and then use that to inform future financial decision-making. There are likely seasonal patterns (holiday rushes or summer slumps) that you can plan for once you aggregate this data.
But wait—what if you don’t have any real financial data to go on? Businesses that are just starting out can use industry research to guide and approximate revenue projections. Try to back up your numbers with data whenever possible and err on the conservative side (overestimate your expenses and underestimate your revenues) to give yourself a cushion.
Hopscotch Habit: Keep in mind that revenue is typically the most important part of your budget and the fastest way to tell how your business is doing. Consistent revenue growth over time is a strong indicator of a healthy business. Unexpected spikes or drops in revenue may indicate that something unusual is happening and you might need to adjust to hit a more steady income stream. If you’re planning to apply for a small business loan or investor funding, you’ll need to have a solid budget in place tracking your income and expenses.
2. Calculate overhead costs
Business overhead refers to fixed costs—recurring expenses that a business pays each month like rent, insurance, and payroll. Fixed costs are not impacted by business performance. This means these costs don’t fluctuate month-to-month based on a company’s production of its goods or services.
As long as you’re in business, you’re going to have fixed costs. Depending on your industry and the size of your business, these costs will vary, and it’s important to include a clearly defined list of these expenses in your business budget.
3. Identify variable expenses
Variable expenses are costs that flex higher or lower on a monthly basis. Unlike fixed costs, variable costs are tied to the production of a company’s goods or services—they trend upwards when production increases and trend downward when production decreases.
Unexpected or infrequent expenses like office supplies and business travel can also be considered variable costs. You should try to identify as many variable costs as possible to get a sense of how much they fluctuate throughout the year. Over time, you’ll hone in on an increasingly accurate understanding of your variable expenses and be able to make precise cost projections in your budget.
4. Plan for fluctuations
The best budgets will expect the unexpected. Let’s say you have a slow month or are still waiting on a big payment to come through from a past contract—you might suddenly be in a tight spot if you were counting on that incoming cash to cover an upcoming cost.
Ideally, an accurate budget will help your business survive curveballs like this. How? A contingency fund! A contingency fund is a pool of money reserved for unexpected costs. It can also help you weather market changes and other financial events that may be beyond your control.
Just like many people do with their personal savings accounts, businesses might want to invest a portion of company revenue in a contingency fund every month. Putting money aside can help alleviate the financial burden you may feel while waiting for a check to arrive or getting hit with a surprise bill.
5. Start growing your business
Once you’ve gathered all the information, it’s time to create a comprehensive view of your finances and expand your business! Having all this information organized in one place will help you maintain a comprehensive understanding of your finances and make better decisions for your business. You can make adjustments as you track the budget throughout the year, reducing spend or investing in new revenue opportunities as needed.
Most businesses, especially small teams in the early days of growth, should plan to regularly revisit and update their budget to drive the best financial decision-making. If your budget reflects the most relevant, up-to-date information, you’ll know exactly what you can afford to spend relative to how much you’re projected to make.
Connect with Hopscotch for additional help
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