For a small business, some of the most essential financial elements make all the difference in long-term profitability and sustainability. Research indicates that as of 2021, just over half of small businesses had a formal budget. The smaller the business, the more likely that business is to not have a formally-documented budget in place.
A small business budget proposes a proverbial measuring stick that allows a business owner to evaluate both current performance and long-term goals. Below is a look at the importance of a small business budget and the five ways to create one.
The Importance of a Small Business Budget
The business owner benefits from a small business budget because this means:
- Gaining more insight for more efficient financial moves
- Learning how much revenue could be used for reinvestment in the business
- Offering a snapshot of what may be anticipated for the future
- Helping the business owner maintain control of business cash flow
- Determining how to allocate funds to avoid debt
How to Create a Small Business Budget in 5 Simple Steps
When getting started, the more historical financial data a business has available, the more accurate and valuable a new budget will be. Nevertheless, even business owners who are just getting started can gather industry cost data to create estimates and forecasts for the financial future. In general, creating a small business budget comes down to five simple steps.
- Examine Revenue and Income Sources
The first step to creating a budget for a small business is to know how much money comes into that business. Look at all income sources. What is important here is revenue, not profit. Revenue is incoming funds before any level of expenses are taken out.
A good goal is to gather revenue data for at least the prior 12 months, but more is better. Gathering historical revenue data for at least the prior year gives a more accurate representation of median revenue and what to expect going forward. Most businesses experience seasonal revenue patterns. For example, a retailer may see a slump immediately after the holidays or an uptick in revenue around spring.
- Determine and Subtract All Fixed Expenses
Next, look at fixed costs. This term applies to necessary, recurring costs associated with business operations, and the costs may occur at different intervals. For example, a business may have daily, bi-weekly, or even monthly fixed costs. All businesses are unique, which means all businesses have their own unique fixed costs to include in a budget. Nevertheless, some examples may include:
- Rent or lease costs
- Payments on loans
- Business supplies
With all fixed costs collected, subtract those from revenue (income).
- Outline Variable Expenses
Beyond fixed expenses, determine variable expenses. These are usually just as necessary for business operations, but they may not cost the same every month. However, variables may also be expenses that may not be necessary for operations but increase profitability. A few examples of variable expenses or discretionary expenses may include:
- The owner’s salary
- Professional development training
- Costs for digital marketing
- Equipment upgrades
- Certain supplies
Once you have a good budget in place that reflects month-to-month revenue and fixed expenses, it is easier to see when variable expenses would be a better fit. For example, if a law firm has a dip in billable hours through the winter, it would be best to allocate funds for variables outside of the winter season.
- Create an Unexpected Cost or Contingency Fund
Great expectations in business, especially a new business, are normal. However, “great” may not always be feasible, and planning for the unexpected is a must. There may be months or quarters when one-time, unexpected expenses or a drastic dip in revenue threaten the stability of the business’s cash flow. When creating a small business budget, it is important to include at least a little slack.
In other words, when creating a budget, implement a contingency fund, or a certain amount of money set aside every month for unexpected events. If the primary elements leave you with a surplus of profit, instead of allocating the whole of these funds to something like a business owner’s salary or new investment opportunities, set at least a percentage aside.
- Formulate a Profit and Loss Statement
When all four of the aforementioned elements are pulled together, use that information to generate a profit and loss statement. This statement gives insight into:
- Seasonal trends in profits and losses
- Month-to-month expenses and how they could be better controlled
- How investments boosted or hurt revenue in concurrent months
A profit and loss statement offers an understanding of how the business financially performs in different timeframes, whether that is week to week or month to month. Further, this becomes a vital document for further financial planning strategies.
A Well-Designed Small Business Budget Keeps Business On Track
A small business budget is the most basic level of business accounting but offers some of the most profound insight into how the business is doing financially. Over time, this one simple data source serves as a guiding foundation for different financial moves.
Need help creating a budget for your small business? Contact The A Team to discuss how we can help with accounting, bookkeeping, technology, and more.