When you become a small business owner, you have to learn how to do a lot of things that you have never done before, such as managing staff, finances, and shipments. To successfully manage your finances, you must be able to create and maintain a small business budget. This may seem like a daunting task, but if you approach it the right way, it’s not that difficult. Here is a guide to help you easily and successfully create a budget for your small business.
Why Do You Need a Budget for Your Business?
A business budget is a critical tool for managing your small business finances. It helps you prepare for the future and ensure long-term success for your business. A budget for your business makes you look past next week or month toward next year or even five years from now. Planning your finances out in advance will help your small business become more efficient in how funds are used. Additionally, a business budget will point out leftover money that you can reinvest, help you predict and plan for slow months so you can stay out of debt, and aid in estimating what it takes to become profitable. A small business budget provides a window into the future, helping you maintain control of your business by spending money in the right places at the right times and avoiding debt.
Creating a Small Business Budget
Step 1: Look at Your Revenue
The first step in creating a budget for your business is looking backwards at your small business to find all your sources of revenue. Start with sales figures first then dig deeper to find other income sources your business has at its disposal. Add up how much revenue your business receives per month, making sure you are using revenue and not profit in your calculations. Revenue is the money that your business receives before taking out expenses, while profit is the money your business makes after deducting expenses.
If you have the data available, calculate your monthly revenue for multiple months, preferably for the past twelve months or more prior to starting this business budget. Examining at least twelve months’ worth of information will help you see how your business’s monthly income fluctuates over time as well as if there are any seasonal patterns. Knowing if your small business experiences a slump during the summer months or after the winter holidays will help you prepare for these slow months in the future and give yourself a financial cushion.
Step 2: Determine Your Fixed Costs
The next step in small business budgeting is determining your fixed costs. Fixed costs are expenses that you have to pay on a recurring basis to support the operations of your business. You may have to pay these expenses daily, weekly, monthly, or annually. Some fixed costs that your small business may have are rent, payroll, supplies, taxes, debt repayment, insurance, and asset depreciation. Because every small business is unique, yours will likely have different fixed costs than just those mentioned here. Determine what all your fixed costs might be for your business and add them up for each month. Then, subtract these expenses from the monthly income you found in Step 1.
Step 3: Identify Variable Costs
After you subtract your fixed costs, the next step in creating a budget is identifying your variable costs. Variable costs are expenses that change depending on the amount produced. Like fixed costs, many of these costs are essential for your business to continue operations. There are also some variable costs that are not essential for operations but are nice to have. These non-essential expenses are called discretionary expenses and can include things like education or other extras that can improve profitability, and they should be accounted for in your variable costs as well.
Some variable costs that your small business may have include office supplies, marketing costs, owner’s salary, utilities, equipment replacement, professional development, etc. In slow months, your small business will need to lower its variable costs, starting with discretionary expenses. In more profitable months, you will be able to increase spending on variable expenses that will benefit your business in the long run.
Step 4: Create an Emergency Fund for Unexpected Expenses
There will be moments when one-time costs come up, and they always seem to occur when it’s inconvenient and your budget is already tight. To prevent moments of panic and fear, your small business budget should include a contingency fund for unexpected costs so that you always have some extra cash on hand. It’s tempting to spend any extra income on variable costs, but it is a better idea to put some aside in an emergency fund. Creating an emergency fund as part of your business budget means you will be prepared and able to afford repairing equipment that breaks down or replacing damaged inventory. An emergency fund gives you more options so that you won’t have to rely on a small business loan and extra debt to afford unexpected expenses.
Step 5: Put Together Your Profit and Loss Statement
Because you have gone through steps 1 through 4, you now have all the information you need to create your profit and loss statement, or P&L. A P&L is a historical document that shows your business’s financial past. Add up all your income for the month, then add up all your expenses for the month and subtract the expenses from the income. If the number is positive, then your small business made a profit. If the number is negative, then it has incurred a loss. If your business experiences a loss for the month, don’t panic. It’s important to remember that small businesses are not profitable every month or every year, especially in the beginning. Your business can recover and make a profit in the future.
Step 6: Create a Forward-Looking Budget for Your Business
After creating your P&L in step 5, you are ready to create your business budget! You want your budget to be forward-thinking to secure the financial future of your small business. When creating your budget, it will be beneficial to refer to your P&L so that you can understand any seasonal patterns, which investments were worthwhile, and any previous financial decisions that should be avoided in the future. Look for trends in your P&L such as:
- Major supply or equipment purchases that result in a beneficial loss
- Seasonal trends that result from weather, natural disasters, or economic stress
- Seasonal trends that result from school calendars, tourism patterns, or limits on supply
- Unusually high profit that cannot be explained
The reason you are looking for trends in your P&L is to see where fluctuations occur and why. Knowing which months are most and least profitable will help you project what the following year will be like. It can also inform you on whether you need to hire additional employees or increase your hours during certain months to help your business meet higher demand and become even more profitable during busy months. Use this information to create a forward-looking budget that allows for more spending during profitable months and reduces spending during slower months.
Hire an Accountant to Help with Your Small Business Finances
Most small business owners got their start because they had a great idea and wanted to do something they love, not because they want to spend their time building budgets and managing finances. If you want to be able to focus on the best aspects of being a small business owner, let a professional accountant help you manage your budget, finances, and taxes. Lawhorn CPA Group is an accounting firm that provides tax, accounting, and bookkeeping services and our Virtual Financial Office is tailored to small businesses to serve as your very own financial team. We offer a complete solution for your small business accounting needs and bookkeeping services, handling your accounts payable, accounts receivable, payroll services, asset management, and more so that you can do what you best – run your business. Reach out to Lawhorn CPA Group today to get started!