As a new small-business owner, you have to figure out a lot of things you’ve never done before. One of them is how to create a business budget — and that can be intimidating, especially when you’re just starting out. How, exactly, do you know where to find the right financial information — let alone learn the business finance terminology — and put all that data together in the right order?
This can all be enough to scare some people away from starting a business in the first place. One study suggests that the majority of small-business owners don’t even have a budget to begin with. But the process of how to create a business budget isn’t actually that difficult if you approach it the right way. It can all be broken down into six steps.
Many people think of budgeting as their least favorite part of running a business — but if you want to be successful, creating and maintaining a proper business budget will be a critical component of that success. Here’s a step-by-step guide for how to create a business budget.
How to create a business budget: Why do it in the first place?
Budgeting for your business is about making an educated guess as to how the future of your business’s finances will look. It requires examining what happened last month, what happened three months ago and what this month last year looked like — then using that information to make wise financial decisions for the months and years ahead.
If you’ve had a few bad months and predict you’re looking at another slow one, you can prepare to minimize expenses where possible. If business has been booming and that video you posted went viral and is bringing in customers, live a little riskier and invest in buying more inventory to satisfy those incoming customers and keep them coming back.
In other words, you don’t need a crystal ball to run a business, but you do need to learn how to create a business budget. And that does take some intuition and educated guesswork to make sure everything continues to run smoothly.
Why you need a business budget
When just launching your business, creating a budget is one of those things that can fall by the wayside. If your business is operating with a significant amount of profit or is going through a boom, it might not seem important to create a business budget.
But a budget can help to ensure long-term success for your business. A budget helps you to see past next week and next month to next year, or the next five years, even.
More specifically, a business budget can help your business benefit by:
Making it more efficient.
Pointing out funds leftover that you can reinvest.
Predicting slow months and keeping you out of debt.
Estimating what it will take to become profitable.
Providing a window into the future.
Helping you keep control of the business.
Creating a business budget will make operating your business easier and more efficient. A business budget can also help to make sure that you’re spending money in the right places and at the right time to stay out of debt.
How to create a business budget: A 6-step guide
As you get started, you’ll notice that the business budgeting process starts with looking backward at your past income and expenses. The longer you’ve been in business, the easier this process will be, as you’ll have more data to look back on as you move to creating your forward-looking budget.
If your business is brand new, however, you might have to do some more extensive research into typical costs within your industry or area in order to gather working estimates for your forecasted finances. A business budget template can also help you get organized.
1. Examine your revenue
The first step in any budgeting exercise is to look backward at your existing business and find all of your revenue (aka income) sources. Add all those income sources together to discover what money comes into your business on a monthly basis.
When finding your income, make sure to calculate for revenue, not profit. Your revenue is all the money that comes into the business before expenses are deducted. Profit is what remains after expenses are deducted.
Once you’ve identified all of your income streams, calculate your monthly income. It’s important to do this for multiple months — and preferably for at least the previous 12 months, provided you have that much data available.
With 12 months (or more) of information, you can examine how your monthly income changes over time and look for seasonal patterns. Your business might experience a slump after the holidays, for example, or during the hot summer months. Knowing about these seasonal changes will ensure that you can prepare in advance for the leaner months, and give yourself a financial cushion.
2. Subtract fixed costs
The second step in creating a business budget is to add up all of your fixed costs. The term fixed costs applies to any cost that is necessary on a recurring basis for the operation of your business. Fixed costs might occur daily, weekly, monthly or even yearly, so make sure to get as much data as you can.
Examples of fixed costs within your business might include:
Depreciation of assets.
Your small business is unique and will have different fixed costs than what’s described here. Take a few minutes to make note of other fixed costs that might be associated for your business.
Once you’ve identified your business’s fixed costs, you’ll subtract those from your income and move to the next step.
3. Determine variable expenses
As you search for the data you need to list out your fixed costs, you might have also noticed there are some variable expenses within your business as well.
Variable expenses are those that change depending on how much you use the service. Many of these are necessary for your business to stay in operation, like utilities.
You’ll also find expenses in here that aren’t necessary for the function of your business, but would be nice to have, like education, or extras that can increase profitability. Those are called “discretionary expenses,” which you can roll into your variable expenses fund, too.
Some examples of variable expenses are:
Replacing old equipment.
During lean months, you’ll need to lower your business’s variable expenses, beginning with discretionary spending. During profitable months when there’s extra income, however, you can increase your spending on variable expenses for the long-term benefit of your business.
4. Set aside a contingency fund for unexpected costs
Whether or not you’ve run a business before, we all know that one-time costs don’t come when it’s convenient. It’s the day before you host your entire family for Thanksgiving and the refrigerator goes out. You’re on the way to the biggest presentation of your career and your car stalls.
These costs arise when you’re least expecting them, and usually when the budget is tight. Prevent fear of unexpected costs when budgeting for your business by making sure you have some extra cash on hand and plan for contingencies within your budget.
Although you might be tempted to spend any surplus of income on variable expenses, put some aside into an emergency fund instead. That way, you’ll be ready when equipment breaks down and needs replacing, or you need to quickly replace inventory that is damaged by flooding. Of course, there’s always the option for a small business loan — but more options are better than fewer.
We hope for every business owner that the maxim holds true: If you budget for a problem, the emergency never arises. And if the emergency does show up? Well, you’ve budgeted for it. It’s not really an emergency then, is it?
5. Create your profit and loss statement
Once you’ve collected all of the above information, it’s time to put it all together to create your profit and loss statement, or P&L.
Just talking about a P&L can bring up feelings of anxiety—we get it. But remember, you’ve already done all the work. And it’s addition and subtraction: Add up all of your income for the month and add up all of your expenses for the month. Then, subtract the expenses from the income and hope you get a positive number at the end.
If you do, you’ve made a profit! If not, that’s a loss — and that’s OK, too. Small businesses aren’t profitable every month, let alone every year. This is especially true when you’re just starting out as a business.
6. Outline your forward-looking business budget
Whether you’re a new business or you’ve been doing this a while, projecting what will happen to your business in the future is educated guesswork. If you’ve been in business for a while, that’ll certainly help the accuracy of those guesses (as you might, well, guess).
Now that you’ve created your P&L — which is a historical document showing the past of your business — it’s time to create your budget. And this is a forward-thinking, future-focused document.
For this step, referencing your P&L will help you better understand the seasonal ups and downs of your business, which investments in your business are worth repeating, and what you should avoid in the future.
On your P&L, look for these trends:
Big supply or equipment purchases that create a beneficial loss.
Seasonal trends due to inclement weather, natural disasters or economic turmoil.
Seasonal trends due to school calendars, tourist travel patterns or supply limitations.
Profit that is higher than in previous years or can’t be explained.
When examining your P&L, you’re looking for ways to explain the fluctuations and changes in your business.
For example, if you operate a popsicle stand, you’ll see higher profit in the summer when the temperatures are warm and kids are out of school. Knowing your most profitable months will help you to predict what your next year will look like. You might also take that information and decide to hire more staff and extend your hours during certain times of the year, making your business even more profitable in the months that demand is highest.
Making budgeting efficient
Most business owners didn’t get into the game to learn how to create a business budget, sure. So, how do you make budgeting efficient so you can get back to the best parts of business ownership? Easy.
Hire an accountant you trust to help manage your budget, course correct when the business gets off track, and make sure you’re paying the necessary taxes.
Break the process of how to create a business budget down into small steps — managing a business budget is much easier when you do pieces of the work over time and tackle a little bit each day or every week.
Put procedures in place for budgeting that’ll help you know where to find the numbers you need, when expenses go out, and where the money you need is located.
There are very few business owners you’ll meet who love budgets, finances, and spreadsheets. That’s simply not why people get into business ownership. But budgeting is part of life when you own a business. So, knowing step by step how to create a business budget and manage it efficiently will make your job as a business owner just a little bit easier.