How to create a business budget

Budgeting for small businesses is essential for staying profitable, avoiding cash flow issues and making smart financial decisions. It shows you where your money’s coming from, where it’s going and how to manage it efficiently, allowing you to fund your business goals and be ready for the unexpected.

Whether you’re just starting out or scaling up, learning how to create a business budget can provide the financial clarity you need for success.

7 steps to create a business budget

Creating a business budget is an essential process for ensuring financial stability.

1. Review past financial performance

Analyze your financial statements, including income statements, balance sheets and cash flow statements to identify trends and better understand your revenue and expense patterns.

You can do a cash flow analysis of the past year to see all revenue and expenses incurred over the year and to see if you had positive cash flow.

2. Forecast revenue

Estimate how much income your business will generate during the budgeting period. Estimated revenue is calculated by forecasting sales and subtracting the estimated cost of goods sold (COGS) or services rendered. Be conservative to avoid overestimating your revenue.

New businesses should research industry averages and benchmarks to estimate revenue. You might also use your revenue from the previous quarter to estimate how much revenue you’ll bring in during the current quarter.

Consider how many income sources you have and whether any of those sources provide predictable income, such as a monthly retainer. If possible, you can create multiple revenue streams within your business to set your business finances on solid footing even if unexpected changes happen.

3. Identify business expenses, including fixed and variable expenses

Categorize your operating expenses into fixed and variable expenses. Understanding these distinctions helps in allocating funds more effectively:

• Fixed costs: These costs remain constant over time, regardless of the scale of your production or any other business activity. For instance, rent is a fixed monthly expense — it doesn’t fluctuate based on how much your business produces in a given month. Fixed costs indicate the minimum revenue the business needs to earn to cover costs that will occur regardless of your business activity.
• Variable expenses: These are costs that fluctuate with business activity. For example, the cost of raw materials will increase if you produce more goods. The simplest way to forecast variable costs is by using historical data. Begin by taking the total variable cost from the previous year and dividing it by the number of units produced during that period to calculate the average variable cost per unit. You can then multiply this number by the projected sales for the upcoming period to estimate your total variable costs.

Include an expense category for irregular expenses, such as new equipment purchases, software or attending a trade show, to avoid surprises and ensure you’re prepared for larger financial outlays.

While recurring expenses are generally easier to forecast, one-time expenses are more difficult to predict. Here, it helps to align your budget with your procurement plans. For example, if you expect significant expenses next year, such as purchasing office equipment or software, be sure to account for these as one-time expenses in your business budget.

4. Set profit goals

Determine how much profit you want to make during the budget period. Subtract your estimated expenses from your projected revenue. If the result isn’t satisfactory, revisit your expense allocations or revenue projections.

It’s common for businesses to make 5 percent to 10 percent net profit, but some businesses can make profits as high as 30 percent, depending on the industry.

There are several types of profit to keep in mind:

• Gross profit: Gross profit is defined as revenue minus variable costs, such as the cost of goods sold.
• Operating profit: Also known as earnings before interest and tax (EBIT), this category includes only the net income a business generates from its regular business operations.
• Net profit: The bottom line or the final profit figure after all expenses have been deducted from total revenues.

^{5. Allocate resources based on your financial strategy}

Distribute resources based on your business goals to avoid over-allocating resources to non-critical areas. For example, if you focus on growing your customer base, allocate more funds to marketing and customer acquisition.

6. Account for unexpected expenses

Unexpected expenses are bound to come up while you operate your business, such as equipment repairs, office maintenance or a need for more raw materials to fill a large order. Make sure that you leave room in your budget or even dedicate a line item in the budget to account for these minor or major emergencies.

Similarly, you can add future expenses to the budget that you know you will spend money on. That way you won’t be surprised by the expense when it arises, such as buying new equipment.

7. Monitor and adjust

As a financial roadmap for the upcoming period, your budget is a living document that requires regular updates. The business landscape constantly changes, and sometimes unforeseen circumstances impact your revenue or costs. Review your budget monthly or quarterly to compare actual income against projections. Adjust as needed to reflect changes in your business environment.

Benefits of creating a business budget

Budgeting for your business isn’t just a financial exercise; it’s a strategic tool that can drive your business toward success. Creating a business budget offers several benefits:

• Improved financial management: A budget helps you gain clarity around your business finances, helping you stay within your means when new opportunities or costs arise.
• Setting financial goals: Business budgeting helps you make strategic short- and long-term goals to move your business forward while knowing how much revenue you need to meet those goals. It also helps you know what to do with extra funds when your business is profitable.
• Enhanced decision-making: A budget gives you the data needed to make informed financial decisions, whether prioritizing investments, identifying areas to cut costs or planning for business growth. It will help you effectively prioritize the right projects and focus areas.
• Better funding opportunities: Whether you’re applying for a bank loan or seeking an outside investor, you will need a financial plan to get funding. Lenders and investors evaluate current, past and projected financial performance when deciding whether to provide financing.
• Risk mitigation: As part of your business budgeting, you’ll want to set up a small business contingency fund. This emergency fund will help you weather financial storms if something changes in your market. You’ll be able to continue funding the business operations until you understand how to overcome the market challenge.
• Improved accountability: Budgets set clear financial targets, ensuring every team stays aligned with business objectives. They can also be compared to the company’s actual financial performance to see how close predictions were to real revenue and spending.

Key features of a successful business budget

Poor planning can lead to differences between a business’s budget and its true performance. To budget more effectively and accurately, be sure to include the following features.

Realistic projections

A budget is only as effective as the accuracy of its assumptions.

Effective budgeting starts by analyzing historical data and incorporating current market research to make realistic assumptions about future performance. Startups without a prior financial track record can use industry benchmarks and market research to guide their estimates.

Adequately categorized items

Break down expenses and income into specific categories, such as operational expenses, marketing expenses and sales revenue. This level of detail helps keep your finances organized and ensures accurate calculations of various types of profit and provides greater clarity about your financial performance.

Alignment with setting financial goals

Your budget should reflect the strategic objectives of your business. Define your strategic objectives, then identify the projects that will drive progress toward each goal and rank them based on their potential impact, cost and potential risks. Allocate resources to areas and projects that support sustainable growth.

The bottom line

Creating a business budget is critical for financial stability and long-term success. Start by evaluating your financial history, forecasting realistic revenue and categorizing your expenses. Regular monitoring and adjustments will help ensure your budget is a reliable guide for making informed business decisions.

Frequently asked questions

• How do I calculate a business budget?

  To calculate a business budget, you need to list expected revenue alongside fixed, variable and one-time expenses. Then, subtract expenses from your revenue to see how much profit your business will make. You can use this calculation to help you allocate money to the appropriate parts of your business to help it grow.

• How do I create a business budget for a new business?

  If you’re launching a new business, use market research and industry benchmarks to estimate revenue and expenses. Adjust your budget as your business generates data over time.

• How often should I update my budget?

  You can update your budget as often as you like to stay on top of any fluctuations. At the least, update your budget monthly or quarterly to account for changes in revenue, expenses or market conditions.

• Should you have a business budget even if your expenses vary?

  Yes. A business budget is especially important if your expenses vary, as it can help you save during inexpensive periods to fund higher-cost expenses. Without a budget, it’s easy to lose control of your cash flow, especially when income varies monthly.

• Should freelancers and sole proprietors have a business budget?

  Yes. Business budgets can help freelancers and sole proprietors track income and expenses, plan for taxes, prepare for irregular income periods, set business goals, and avoid overspending or mixing business and personal finances.