When starting and running a business, it seems as though there are countless things that you have to consider. One of the most important, though, is creating a detailed budget, so that you can carefully manage your revenue and expenditures, and keep an eye on your cashflow.
Despite your reservations, building your business budget doesn’t need to be a gruelling task, either. If approached proactively, this whole part of the process can even evolve into an essential exercise in understanding the scope and depth of your venture.
To help you try and make it as simple as possible, we’ve put together seven steps that will help you build a complete and comprehensive business budget.
1. Identify each component of the budget
The first step towards building a business budget is to break down and map out each component. If you already have a chart of accounts for your business (issued by your accountant or bookkeeper), you can use each account as a component in your budget (many accounting programmes even have a budgeting feature built-in). If you are a startup and have not yet put together (or been issued) a chart of accounts, then this is the perfect opportunity to develop one*.
The components of your budget will encompass all of the classes of income and expenditures you plan to make in a given time frame (usually the next 1-2 years). Include any cashflow elements that fall into these categories:
- Funding from investors
- Loans (and periodic repayment of loans)
- Sources of revenue from within your business
- Various income streams outside of your usual business (ex. investments, liquidation of trades)
- Purchases of assets
- Startup costs
- Operating expenses (including all costs of goods sold)
- Administrative expenses
When laying out the components of your business budget without a premade chart of accounts, ensure you take sufficient time to research the costs of your competitors (if possible) and other similar businesses in your industry. This will prevent unexpected expenditures down the road.
Don’t forget to include a 4% margin for error and malfunction, either. This figure will be allocated to your contingency fund later on.
* - Note that any chart of accounts you develop yourself should be reviewed and finalised by an accounting professional before implementation.
2. Research relevant data
As with most aspects of business development, thorough research is vital to effective business planning and budgeting. Researching costs and variable data relative to your niche will help you define a realistic figure for each component of your budget.
If you are the owner of a business that has already been operating for over a year, take stock of your revenue and expenditure figures for the previous year and mindfully appropriate them to the next year’s budget. While some numbers may not be an accurate reflection of what you would generally expect from a given component, use your discretion as needed.
Some good starting points of reference are your country’s and region’s business data banks. As transparent operations are on the rise, you may also wish to scour your competitors’ websites to see if they have made their financials available to the public.
Paid research agencies are also readily available if you wish to outsource the task of market research in whole or in part.
3. Break down projected sales volumes
In this step, break down each component of your revenue and define how much of that component you realistically expect to sell in the given time period. It is easiest to do this monthly, particularly if one or more of your business offerings is affected seasonally (it is rare for businesses to be unaffected by seasonal changes).
Be as specific as possible when you are classifying your revenue streams. If your business sells hundreds of different products and services, then obviously projecting sales volume for each item is going to be impractical, at least in the beginning. With that said, if that is the case for you, then do your best to group items into small classes of related products and services.
Differentiating the product classes will also serve as a valuable tool for charting which products and services are turning a profit, and which should be discontinued, later on.
For your product offerings, take the time to note the cost of goods sold for each item or class at your projected sales volume, as well as at what quantity the costs of goods sold will increase (i.e. if sales come in under budget). Doing so will prevent low volume price spikes from becoming an unexpected marginal expenditure.
You should also take time to research the cost of goods sold and find suppliers with the best price. Any savings you find in your product costs will provide you with some wiggle room in your sale pricing and a marginal advantage over your competitors.
4. Draft a realistic forecast of your revenue
Using the projected sales volumes from step 3, calculate the expected revenue by multiplying your sales price (cost of goods or services plus the cost of goods or services multiplied by profit margin) by the projected sales volume for each item/class/service. Add these together for each month to determine the forecasted revenue for each month of your budgeting cycle.
You may wish to revisit this step after calculating the impact of your fixed expenses on your projected gross margin for the period.
5. Label fixed and variable costs and establish values
It is essential to distinguish between fixed and variable costs when developing your business budget. Fixed costs will occur consistently, periodically and generally in the same amount (or close to). Variable costs will be dependent on sales volume, product usage or other contingency.
Examples of fixed costs (sometimes referred to as overheads) are loan payments, insurance, rent, janitorial and payroll. These costs will not vary from month to month, as they are not affected by sales volume, product usage, or other contingent business operations.
Variable costs, on the other hand, are contingent and usually depend on sales volume. These include costs of goods sold or costs of services rendered, advertising and promotional expenses, office supplies, utilities and commissions.
6. Set aside a contingency fund
Unforeseen circumstances and mistakes, such as accruing bank charges, are an inevitable part of owning and operating a business, so you should implement a margin of error. The industry standard for this contingency is 4% of your projected expenses. Factoring the margin of error into your business budget may feel uncomfortable, but it is an integral part of planning ahead and ensuring that you are prepared for whatever comes your way during day-to-day operations.
An excellent way to set up an accessible (and profitable) contingency fund is to add a designated savings account within your business bank account specifically for holding these funds. With this method, you won’t risk spending your contingency fund accidentally (it does happen!). Additionally, the fund will accrue interest if you don’t use it but will remain accessible as soon as you do.
7. Review the budget as needed
How often you review your budget is up to you. As a general rule, it is recommended to review business budgets monthly, especially during the first few years, and also when you encounter substantial unforeseen expenses.
When unforeseen expenditures arise, it is important to factor them into the budget and adjust figures accordingly, effectively mapping out how your profit goals will still be met. If you find you are encountering a significant amount of unforeseen expenditures in your first few months, classify them as best you can for reference in the future and consider increasing your contingency fund by 25 to 50 per cent.
Remember: budgeting isn’t as easy as jotting numbers down on a page and running with it. Effective budgeting takes careful planning, research and attention to detail. Don’t be discouraged if you struggle with it in your first few years and certainly don’t be afraid to seek out help and professional advice.
The most successful budgeters learn both their business and their industry inside out. Take mistakes as stepping stones and unforeseen circumstances as learning curves, and your budgeting skills will pique in no time.
What budgeting advice would you give? Let us know in the comments below.