November 10, 2020 By SmartBiz Team

A business budget is more than just a plan for spending the money your company earns. It’s also a blueprint toward business success. When you make a budget, you can properly evaluate what you’re spending and why you’re spending it, then use these data to inform your future spending plan. This thoughtful financial planning is essential for smart business operations.

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Why is budgeting essential?

When you review your company’s current finances and plan for long-term financial goals, you’ll know what costs to cut and how you can spend more effectively to expand your operations. If you notice that one of your products or services has become significantly more popular than the others, you’ll know to purchase more goods that help you improve or offer more of that product or service. Likewise, if you notice that you’re losing money on certain products or services, you can reduce or eliminate your spending on those.

Additionally, with a thorough and organized business budget, you’ll face fewer obstacles securing funding from lenders and investors. Neither of these funding sources is likely to work with your company if you can’t provide a transparent and easy to follow guide to your expected income and expenses. And without that extra funding to grow your business, you might not have what you need to meet the financial goals you’ve set in your budget.

How to make a business budget

Now that you understand why a business budget is important, it’s time to make one. Your first step is to learn all the components that comprise a business budget plan, which include:

  • Your income and income sources
  • Your fixed costs, which don’t change each month
  • Your variable costs, which are paid every month but the amount changes
  • Your predicted one-time purchases, such as new equipment

Before you learn more about each of these categories, you should understand what separates the money your products and services bring in from the money you’ll keep.

The difference between profit and revenue

While you create a budget, it’s important that you not conflate profit and revenue. The latter is merely a part of the former: Profit is revenue minus costs. There are two types of profit, gross profit and net profit, that you’ll want to calculate as part of your budget. Use the below two equations to obtain these figures:

  • Gross profit = revenue - the cost of goods sold (COGS)
  • Net profit = revenue - COGS - fixed costs

In some budgets, you’ll see profit referred to as income and costs as expenses. Regardless of terminology, your goal will always be to maximize your profit or income (or at least keep it above zero). There are certain steps you can take to increase your chances of maximizing your profit.

How (and why) to use financial forecasting for budgeting

If you want to know now whether your business stands to make a profit over the next few months, financial forecasting can help paint a clearer picture. Through financial forecasting, you’ll use your previous financial data to predict your expected future revenue and costs. With the clear financial picture that forecasting paints for your company, you can determine when to reorder inventory, analyze the revenue impacts of recent marketing efforts, and make other key business decisions.

You might get the sense that financial forecasting has the same pros and cons, not to mention methodology, as how to make a business budget. You wouldn’t be wrong – the two have extensive overlap. That’s why knowing the basics of financial forecasting can be great for establishing a monetarily sound business plan. Steps you should take include:

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1. Research past years - go back as far as you can

When starting your financial forecasting journey, you might be tempted to look solely at your most recent month or two to predict your upcoming revenue and costs. This approach, though well-intentioned, would be a mistake. Instead, if you have financial data for at least one year (preferably more) of your company’s operations, build your forecast from that information instead.

You just can’t get a proper picture of your business’s long-term future without considering the longer term behind it. For example, if you’re forecasting your budget in December using your October and November data, you might fail to account for a big annual conference that takes place in April.

2. Identify your fixed and variable costs

As you can see from the previous example, identifying costs is important for crafting an accurate budget forecast. So too is determining which of your costs are fixed and which are variable.

Your variable costs may include:

  • Labor. If you hire temporary employees, your labor costs will fluctuate. Labor costs also fluctuate as your company upsizes, downsizes, or gives raises to employees.
  • Commissions. Employees whom you pay on a commission basis will rarely make exactly the same amount in commissions each month. Seasonal factors may vary their sales quantity per month and thus the commission you pay these employees.
  • Utility bills. When you’re not running air conditioning in your office and warehouse in the winter months, your AC bill will decrease. Then again, you might pay just as much for heat during these months, though in some cases, gas rather than electricity will heat your space.

Your fixed costs may include:

  • Rent and leases. The amount you pay per month to rent an office space or lease work-related machinery is unlikely to fluctuate from month to month.
  • Insurance premiums. The monthly premiums you’ll pay for most insurance plans don’t vary by month, though they’ll sometimes change between calendar years.
  • Interest. The interest rates you pay on any loans you’ve taken are unlikely to change over the course of a year.

3. Set your target profit margin

With your forecasting data in hand, you can calculate expected future profits. You can also calculate your target profit margin, a metric that can be more meaningful than profit itself. Whereas your profit tells you how much money you’re making, your profit margin shows you how much of your income originates from sales. You can learn more about profit margins and their importance, calculation, and meaning via the SmartBiz Loans blog’s guide to small business profit margins.

4. Set up a contingency fund

To supplement your budget, plan to reroute a certain percentage of your profits toward a contingency fund. You can use this fund to cover any unexpected expenses and occasional, one-time costs outside your budget, though doing so can be risky. And even if you never use your contingency fund, it at least improves your cash flow.

Budgeting worksheets and calculators

Even with a contingency fund in place for unexpected expenses, your budget will always fluctuate. You can expedite pressing budget adjustments using budgeting worksheets and budgeting calculators. These and other budget and business plan templates can prove especially helpful if your company works in an industry with very specific costs or spending models.

The different types of business budgets

Certain sectors may have different kinds of budgets than others, such as:

  • Seasonal businesses. If you operate a seasonal business, you might still have to pay rent on your office or storefront even when your company isn’t operational. Your budget will thus have certain months with less revenue – and you’ll have to use revenue from other times of the year to cover these months’ expenses.
  • E-commerce businesses. Since the dominant form of e-commerce income is sales, your budget might look a little different. You don’t have multiple sources of income, and you can’t invest in improving one service since all your services involve selling. You’re also likely to have more shipping costs, and possibly warehousing costs, than other types of businesses.
  • Service businesses. A service business budget shouldn’t differ too dramatically from a standard business budget as described here. You just might have less flexibility to make budget changes if you notice sales of one service lagging behind another since you don’t also sell products.
  • Startups. Rare is the business that winds up in the black upon launch. In fact, most companies require several years to become profitable. That’s why a startup budget might need to account for income beyond what you can make from your products and services. Funding options when your revenue is low include small business loans.

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