It’s important to figure out how to create a business budget as a new small-business owner. When you’re just starting out, finding the right financial information and putting all the information together can be an intimidating process. But it is not as scary as it sounds if you approach it the right way, and the process of how to create a business budget can all be broken down into 6 steps. Budgeting might be many people’s least favorite part of running a business, but it’s essential to maintain a proper business budget in order to keep the business running smoothly and successfully.
When your business is doing really great and creating a lot of profits, it might seem unnecessary to create a business budget. But a budget seems necessary when it comes to long-term success for your business. A budget helps you make an educated guess about your business future financial situation, like see past next week and next month to next year, or next 5 years. Having a business budget enables you to operate business easier and more efficiently. It can also help your business stay out of debt by ensuring you’re spending money in the right places at the right time. There are some other advantages to creating a business budget such as highlighting funds leftover that you can reinvest, and providing a window into the future.
How to create a business budget: A 6-step guide
It’ll be easier for experienced business owners because you’ll have more data to look back on as you create your forward-looking budget. If you’re just starting out, some more extensive research into typical costs within your industry or area might be needed. Whether you’re collecting information from your own business or making educated guesses based on research, there are 6 steps to create a business budget.
Let’s break down each step.
1. Examine your revenue
The first step in creating your budget is to review your income amounts and income sources from previous months. The more information you have the better. Ideally, you should use at least 12 months of revenue information. Then, you should analyze this information and look for an average revenue amount per month, seasonal trends in your business, and if sources of income will continue to be sources of income. Some businesses experience "busy" seasons and "slow" seasons and knowing if your business has any of these trends will help you prepare for them.
2. Subtract fixed costs
The second step is to subtract fixed costs. Fixed costs are business costs that are constant despite changes in the quantity of goods or services produced such as rent and payroll. Before subtracting fixed costs, you need to find the total of your fixed costs. Ideally, you want to identify the monthly fixed costs amount. Once you have calculated the total of your business's fixed costs, subtract that total from your revenue.
3. What are your variable expenses?
The next step is determining the variable expenses you incur when running your business. Many variable services are imperative and necessary to have to ensure your business can stay in operation. Unlike fixed costs, variable expenses continuously change based on how often services are utilized, i.e., utilities. There are other variable services that may not be necessary to have but could just be nice to have because they help increase profit, i.e., education. These types of variable expenses are called discretionary expenses.
A few examples of variable expenses include:
During your analysis of monthly income, it is important to figure out when to decrease or increase discretionary spending to ensure the business is operating efficiently and making profit.
4. Plan ahead by creating a contingency fund for any unforeseen costs
One-time costs are hard to prevent since they typically arise unexpectedly. That is why it is so important to take unexpected costs into consideration when building your budget but ensure that you have extra cash on hand. You may be tempted to utilize any extra cash laying around for discretionary expenses; however, it is in your best interest to have an emergency fund in case you run into any financial or operational problems in the future. In doing so, you will be prepared to purchase new equipment if your old one breaks down, or if you are on a time constraint and need to replace inventory that was damaged by a flood as soon as possible. The point is – anything can happen when you least expect it, so it is best to plan ahead.
5. Create your profit and loss statement
Now you’re ready to start putting together all the information that you’ve gathered so far to create a profit and loss statement. The profit and loss (P&L) statement gives a clear view of the revenues, costs, and expenses incurred during a specified period, usually a fiscal quarter or year. The information gathered from the P&L can be compared to prior periods to see how profitable your company has been over time.
To create a P&L statement, first add up all your income for the month, then add up all the expenses for the month as well. You will then subtract your total expenses from the total income. The result will be your profit for the month. A positive number means you’ve made a profit, however a negative number means it’s a loss.
6. Let the P&L guide your budget
The purpose of a profit and loss statement is to give you an idea of the financial state of your company over a period of time. This financial record is useful as a reference for building your budget. By comparing the seasonal fluctuations of your company, you then make predictions on how your company will do in the future. This view into past trends helps you make better decisions and avoid missteps.
While referencing your P&L to build your budget, look out for these trends:
Recognizing and interpreting the trends that occur in the profit and loss statement allows you to make better decisions that help increase the profit of your business . By tracking when and why sales drop during a certain time helps you plan ahead for similar occurrences in the future.
By utilizing these two powerful tools, the profit and loss statement and your budget can help you make better business decisions and improve your company’s profitability.
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