Budgeting for Small Business

Starting your own business is no small feat. You may have the next big idea or all the funding in the world, but if you don’t have a solid budget, it could all fall apart.

And let’s face it; budgeting isn’t exactly the coolest thing. Many small business owners don’t even know where to start. They know that they need to fund their operations, account for expenses and revenue, and hopefully expand their business and generate enough profit to grow. However, putting this into action can be daunting.

That’s where smart budgeting for your small business comes in. But what does it do exactly?

A smart budget:

• Prevents overspending
• Illustrates profits and losses
• Establishes an emergency fund, also known as a contingency fund

This easy-to-follow guide will help you build a proper budget for your small business.

What is a business budget?

A business budget is really just a game plan. Based on your financial history and current expenses, you can build your budget to fit the custom needs of your business. A proper budget provides a thorough overview of where your money has been spent, and where it could be spent in the future. Staying on top of your financial plans encourages solid decision-making and spotlights potential growth and expansion opportunities.

It is also important to note that a budget is best used in context with your current market and business climate. This includes the global economy, the state of the stock market, and interest rates. You should also consider the local economy, including the unemployment rate and the average income in your area.

When reviewing your own numbers, you might notice consecutive slow months, confirming concerns you might have. Or if you’re looking during your busy season, you might be more likely to take some risks! Either way, it’s important to consider the context when creating your budget.

Basic components of a business budget

Every budget is different, but some expenses are common across all businesses. When you start building your budget, consider the basic expenses.

Common business expenses include:

• Rent or mortgage payments for the physical workspace
• Payroll expenses and established salaries
• Tax payments
• Cost of goods and materials sold or required for offered services

It is important to focus on your expenses as you fully examine your revenue. Once you’ve reviewed your expenses, you can subtract your fixed costs from your overall budget. We’ll talk more about fixed costs later. You’ll then decide which costs are variable expenses, set aside a fund for emergencies, analyze your profits and losses, and make an informed prediction about future budget requirements. These pillars build a foundation for an effective business budget.

Why do you need a budget for your business?

Knowing your costs and expenses is the crucial first step toward cultivating a successful business budget. It is imperative that you factor in any and all costs, whether they are fixed or variable.

These changing costs ensure that your budget is a living document that can grow and change with your business. Your detailed budget will keep you ahead of the game as revenue increases and expansions become necessary.

How to create a budget for your business

Here are the main steps to take in order to build your perfect budget.

• Total up your sources of income
• Identify fixed costs and variable costs
• Predict what extra spending may be required
• Review your cash flow
• Make informed predictions about future budget needs

Analyze your revenue

Your revenue is the lifeblood of your business. Depending on your industry, there are several ways to pick apart your revenue. Finding one that fits your field may take some trial-and-error

One popular way is to analyze revenue by considering how your revenue relates to your employees. This also doubles as a human resources review. Simply divide your sales revenue by the number of employees, and you can approximately determine how much revenue each employee produces on average. This is referred to as the revenue-per-employee ratio and can be a useful tool in financial analysis.

Consider all the fixed costs

It’s always nice to know what to expect. With every business budget, there are unavoidable costs that do not change. Your rent, your employee salaries, loan repayments, and insurance plans are common fixed costs. These expenses are your first consideration once you’ve totaled up your income. Fixed costs are like the facts of life – nothing affects them, and they can’t be avoided!

Determine all your variable expenses

Things like rent and salaries are fixed costs to factor in, whereas labor commissions, utilities, and costs of goods can be variables. While you may not know the exact figures of the variables, it’s important to estimate based on previous years. As time goes on, it will become easier and more accurate to make these estimations.

Account for one-off costs

Outside of fixed and variable costs, your budget will have to account for any one-time expenses, whether they occur ad hoc, such as equipment repairs, or only at certain times in the year, like taxes.

To stay up-to-date, keep a calendar relevant to your business’s occasional expenses and refer to it each month when budgeting. Foreseeing seasonal needs and monitoring industry trends are both vital parts of the budgeting process.

Set aside a contingency fund

A contingency fund is essentially a "rainy day" fund that can be used to cover unexpected costs or expenses. For example, if you need to make repairs to your office or replace damaged inventory, your contingency fund can help you cover those costs without putting a strain on your operating budget. Having a contingency fund can also help you weather slow periods or unforeseen bumps in the road.

Setting aside a contingency fund may seem like an unnecessary expense, but it can actually save you money in the long run. By having a cushion to fall back on, you can avoid having to dip into your operating budget (which could put your business in jeopardy) or taking out expensive loans.

Factor in seasonality and industry trends

Nowadays, there are several pieces of software that can analyze your financial data and make informed predictions of potential growth plans for your budget. You may have heard this software referred to as Business Intelligence Tools, or Predictive Analytics programs. These programs factor in financial trends within your business.

A very popular budgeting trend that many businesses are utilizing is cloud-based software as a means to track spending. Creating a budget within a cloud maximizes efficiency and accessibility across departments, boosts security, and can cut down on overall IT costs.

In the wake of the COVID-19 pandemic, many businesses across the country are taking fewer risks and minimizing spend to prepare for the unpredictable nature of closures and employee illness. Cost control has become more important in recent years, and conventional budgeting models may not work in the current climate. Business owners are encouraged to evaluate past budgets, closely monitor performance, and consider leaner scenarios. For any trends and changes outside of the expected, a healthy contingency fund could be the difference between staying alive or going belly-up.

Create your profit and loss statement

Everything comes down to profit. That’s why many companies utilize a profit and loss statement to zero in on what is arguably the most important part of any business’ budget. For any particular period, a business can gather together all financial statements within the desired time frame and analyze how revenue becomes net income or net profit.

This simplified perspective demonstrates an entity’s ability to generate sales, garner profit, and identify losses that can be avoided in the future. Synthesizing the information from several P&L statements can highlight trends in profitability and prevent downward trends from happening.

General categories within a P&L statement include:

• Cost of Goods
• Administrative expenses
• Research costs
• Marketing expenses.

There are several templates available for you to utilize and customize to fit the unique needs of your company.

Prepare your forward-looking business budget

So it’s the end of the fiscal year. You’ve kept additional expenses down, and your emergency fund did not need to be touched all year. Your new product launch was successful, and your profits are steady and sky-high. Now, you can consider taking bigger budget risks, since you don’t have as far to fall monetarily.

There are a few things to consider as you look forward to the next year, especially after a successful year or quarter. Plan new projects thoroughly, and maintain positive relationships with vendors. It’s also important to keep your board members and stakeholders informed of any big expenses or risky spending. Communication and detailed spend-tracking become key when you take a big dive with your extra funds. And again, keep your contingency fund plump and secure.

Tips for managing a business budget

There are several strategic ways to manage your budget. If you have several departments within your company, look back at the last fiscal year and analyse revenue from each department. This is a great way to locate parts of the business that may need more funding, parts that have a surplus budget that could be spread to other areas, and parts that are adequately supported.

When separating budgets by departments, delegation becomes imperative. There is nothing more valuable than having several sets of eyes on something as detailed and meticulous as a budget. Assigning budgetary management duties to higher-ranking members of each department encourages individual accountability as well as collaboration, as your budget as a whole will require management and balance between each department. The goal is for your budget to work as a cohesive whole in addition to satisfying each department’s needs.

Additionally, a budget must be monitored regularly. Keeping an eye on your company’s spending habits and adjusting accordingly can help prepare you for your company’s next fiscal year and catch errors before they reach your customer. Following the cash flow, and tracking the fluctuation of variable costs works to prevent money laundering and analyze cost trends.

Finally, the greater purpose of a budget’s existence is ultimately to inform the future. An informed forecast can be made when considering the previous years’ expenses and revenue. From a financial standpoint, ask yourself–where is your business now? And where will it go? If your numbers are current and accounted for, you can gain a clearer understanding of viable growth opportunities and potential budget diversification.

Invest in an accounting software

But what good is a business budget without accuracy? The best way to manage your budget, along with frequent monitoring and departmental delegation, is to ensure that your records are accurate. Accounting software has increased in popularity over the past few decades, and its advantages work to serve small businesses and guarantee accuracy. Software streamlines your information and adds an additional layer of security and protection to your valuable assets.

Popular account softwares used by modern business include:

• FreshBooks
• NetSuite ERP
• QuickBooks Online
• XeroSage
• FreeAgent

Budgeting software makes developing financial plans and sticking to them so much easier. Many budgeting softwares allow you to link a bank account for credit score checks and investment tracking. If you separate your business by department, account software will be vital to managing each department’s fixed and varying expenses. A centralized accounting system will help gather each department’s budget into one cohesive budget for your business.

Review the business periodically

We’ve got a few helpful questions to inform your periodic budget reviews. Take a look at your finances, and ask yourself:

• Have your goals been met?
• Were there any unexpected costs this year? Will they occur again? Are they fixed amounts or will they vary?
• Is there a need for growth within your employee base?
• Are your rent/utility costs expected to increase or decrease?

Negotiate with suppliers

Negotiating with suppliers for a lower price can be a good way to make connections and save some money on necessary supplies or services. Before attempting to negotiate, know what you’re getting yourself into. Do some research on the costs and availability of whatever you are negotiating. Don’t take their word on the “going rate” or go into a negotiation without any insight or context. If you know the ballpark, you can play the game and get a fair deal without being misled.

Your research should also inform your vocabulary as you go in to discuss a lower rate. If you receive a detailed quote for an elaborate service in an unfamiliar field, you will want to know the jargon and be able to identify exaggerations or unreasonable prices. Be sure to communicate as you reach a deal. Are you getting what you need? Are there certain parts of the arrangement you’re willing to sacrifice to get a lower rate?

For the most effective negotiation, shop around a little and get multiple quotes from different vendors and suppliers. Long-standing business relationships hold value, but if prices are growing and your budget is suffering, it may be worth establishing a new connection with a cheaper provider. Remember your power as a business associate; you are a potential reference for the vendor you are soliciting, and they should appreciate your support of their business.

Also, be aware of time. Frequently, suppliers will offer a discount for early bookings and arrangements. Saving money is the name of the game, and staying ahead of the game takes focus and attention, but costs very little!

Involve your employees

Financial innovators have been experimenting with the idea of Participative Budgeting. According to the Corporate Financial Institute, participative budgeting is a modern concept that recruits members of lover-level management for various budgeting tasks and reform. The goal of participative budgeting is to involve more members of your team, enriching a sense of ownership and pride in a company’s most precious and valuable resource. The richer perspective also helps to create a more realistic and achievable goal, as these newly-included members of the budget team have frontline experience and authentic and immediate perspective.

Enforcing a participative budget has many benefits, including:

• Moving information and feedback up the ladder
• Encouraging employees by giving them a voice
• Aligning company goals with your employee’s professional goals

Don't underpay yourself

As you may already know, business owners, or those employed by their own business, are required to pay income taxes and unique self-employment taxes four times every year. The IRS issues penalties for underpayment, which can be avoided by paying 90%, if not more, of taxes owed for a given year — or 100% of the liability from the previous year. Also, be advised that you are responsible for 110% of the tax liability if your adjusted gross income on last year’s return is greater than $150,000.

Avoid underpaying yourself by making the correct tax payments throughout the year. Quarterly analysis of income and expenses can keep you out of hot water with the IRS.

Keep an eye on the company's objectives

Setting budgetary goals can increase morale, boost performance, and focus your budgeting efforts into tangible results. Since profit is king, many business owners base their budgeting strategies on potential profit increases. A specific profit expectation is set, and a budgeting strategy is built backwards from that goal.

The most effective profit-based goals work to increase sales while keeping expenses the same, or less. For example, your company may discontinue the sale of a product that is costly and unpopular to leverage reductions towards producing more popular products.  The business may also use the savings from discontinuing the costly product to increase advertising and visibility or rebrand a popular product to a new market.

If your business is off to a strong start, your goals may be more growth-oriented. You may see gaps that can be closed or additional employment opportunities that have become necessary as the workload has increased. Is there a justifiable need for a new office? Additional training materials? New technology to increase productivity? If your profits are steady, focusing on growth can be incredibly beneficial to your business's lifespan.

Be realistic and flexible

As of summer 2022, our country is still facing financial strain and supply-chain challenges in the 2nd year of a global pandemic. Certain industries are still hurting from COVID, while others continue to thrive. Keep an eye on businesses that are similar to yours, or within the same industry and see how the current climate is affecting their popularity.

Flexibility can be hard to find within a strict budget. This is why your contingency fund is crucial. Keep a healthy cushion for yourself, and you’ll hopefully avoid experiencing rock bottom.

Finally, set realistic goals for your business. If profit margins are thin, don’t increase material costs or hire new employees. The focus may need to be on internal growth or identifying ways to cut costs and save. Even if that shiny new office building downtown is for sale, if now’s not the time to expand, don’t take the risk. Refer to your accounting team or a third-party financial planner to see what goals are realistic for your business as it stands.

Business budget example

By tracking income and expenses, a budget calculator will help you to make informed decisions about where to allocate resources. There are a variety of business budget calculators available online, and many accounting software programs also offer budgeting features. However, you can create a simple one yourself, just using a spreadsheet.

Here’s an example:

Business credit cards, such as the Capital on Tap Business Credit Card, issued by WebBank, help to centralize your business expenses, build credit, and accrue rewards points that can be used to pay off your balance!

You are also able to monitor and limit employee spending with business credit cards. With your Capital On Tap Business Credit Card account, you can provide an unlimited amount of company cards to your employees. Main account holders are able to set spend limits for each card, and users will enjoy no annual fees or foreign transaction fees. With the ability to set spending limits on employee cards, you can consider their expense as a fixed cost in your budget, with no risk of going over!

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