It is safe to say that people become small business owners for many different reasons. For example, consider the gardener who becomes a florist, or the cook who finally opens that restaurant.
But whatever their reasons, you can bet that all different types of entrepreneurs probably have one thing in common: They didn’t go into business because they love financial statements, or balance sheets, or analyzing operating expenses, or making small business budgets (unless, of course, they’re an accountant, but I digress).
In fact, according to QuickBooks, “Nearly 61 percent of small business owners didn’t create a budget for the 2018 fiscal year. And only 26 percent of organizations with one to 10 employees formulated a business budget.”
But that is a big mistake.
Think of it this way–would you ever get in your car, put a blindfold on, and drive off? Of course not. With a blindfold on, you would never know if you were headed in the right direction, you could not see any dangers down the road, and you wouldn’t even know if you had enough gas to get where you want to go.
But that is exactly the situation when you run a business without a budget. Without one, you will not have a clear idea of income and business expenses. Without a budget, you might have a vague idea of your profitability, and money situation, but you really don’t know if you have enough money to get where you want to go. Creating a good budget allows you to see clearly, get your bearings, see where you are, and head in the right direction. You’ll be confident and armed with the information you need to make smart decisions.
Essentially, there are three different types of business budgets:
The first, and the one we will be diving into here, is an Operating Budget. This is what most people think of when they think about business budgets. An operating budget looks at revenues, costs, overhead, expenditures and so on.
The second is a Financial Budget. This sort of budget is a deeper dive—beyond income and expenses—and adds in assets, liabilities, and owner equity.
Finally, we have a Master Budget. A master budget is as the name implies—it coalesces the other budgets into one overall financial statement.
How are those budgets created? Read on, but in short, there are five elements that go into business budgets.
- Income: Needless to say, all budgets are and must be based on the regular monthly income of the business.
- Fixed costs: Fixed costs are those that are not dependent on sales volume or activity and, as such, are not impacted by that.
- Other expenses: What other ongoing payments do you have in your business? Account for them. These are things like labor costs, advertising, and so on.
- Unplanned expenses: As you will see, we highly recommend that you create a rainy day fund for the unexpected or for those things that are more wants than needs. Should you need to close the doors for a few months because, say, a pandemic strikes, a fund for unplanned expenses would come in very handy.
- Savings: Finally, creating a savings account as part of your budget is the prudent thing to do.
Steps to Creating a Budget
Let me also suggest that another reason too many small business people put off budgeting is simply the word itself: budget. Not a lot of people like that word, entrepreneurs especially. Budgeting often connotes restriction, and especially with the freedom that entrepreneurship can bring, constraint can feel alien.
So consider this instead: Substitute the word “plan” for “budget.” Because, really, that is all that a budget is—it is your financial plan for your business. Would you like to grow your business this year? Great, then you probably need to spend more on advertising and marketing. Make that part of your plan. Are you spending too much on labor? OK, make that part of your plan too.
Step #1: Look Back
You begin the basic budgeting process by analyzing your expenditures for the past few months. If you have accounting software like QuickBooks or FreshBooks, this info is readily available at the click of a mouse. Alternatively, you could dive into your business bank accounts and crunch some numbers. Or, simply track all of your spending for three months. Note all expenses, however paid–cash, card, Apple Pay, PayPal, Venmo, whatever.
Whatever system you choose, the point of this exercise is to see where you are spending your money (so that you will be able to see where you would rather spend it).
Create as many categories as you can and faithfully input where your business is spending money right now. Again, there are many excellent software programs you can use that will generate some fancy pie graphs, or you could also simply create a spreadsheet using Excel.
Step #2: Analyze Revenue
Having looked at your expenses, step two is to look at your income sources, your business revenue (note: NOT net income). Needless to say, most business owners already have a pretty good idea as to where their income comes from. But, that said, doing a deep dive may uncover some nuggets of information.
The key to this part of the budgeting process is to calculate, identify, and label all sources of monthly revenue for the past three months. Your revenue list might look like this:
Website sales: $_______
Google AdSense income: $_______
Amazon store sales: $_______
Sales from the physical shop: $_______
Income from trade shows: $_______
Total Income: $_______
Then do the same thing for September and October (or, of course, whatever three representative months or period of time you choose).
Not only will this exercise give you a great snapshot of overall revenue and its various sources, it will equally spotlight business performance, sales volume per month, and your average monthly income.
If you have the data available, an even better drill would be to do this for the preceding 12 months. This would give you a great view of the seasonality of your small business. Are summer months really as bad as you thought? How good were the holidays actually for your business last year?
By seeing what comes in, and when, and in what amounts, you will begin to get a clearer picture about the overall financial state of your business.
Step #3: Calculate Fixed and Variable Expenses
Any business essentially has two types of costs: Fixed and Variable.
Fixed costs are those expenses that you are required to pay every month to keep the business running. These are things that generally do not change (or don’t change much):
- Supplies and inventory
- Business loans
Variable costs are those expenses that are more discretionary. They change depending upon your goals, commitments, actions, and needs. Variable costs would include things like
- Marketing and advertising
- Office supplies
- Bonuses (discretionary and non-discretionary)
- Travel and entertainment
- Owner’s draw
Step #4: Add It All Up
Now we get to the good stuff. Now we begin to create the road map for your operating budget.
Armed with all of this data, making a monthly budget–errr, plan!–should be fairly simple. The basic steps to creating your own small business budget template are these:
- List your average monthly business income
- Subtract fixed costs (because these are required and do not change)
- The result will be your discretionary budget:
Fixed costs are your core expenses, that is, these are those items that do not change monthly and as such, indicate how much you need to earn in order to break even. Once those costs are subtracted from your monthly income, you will end up with an amount that is more flexible, that is, the amount you have left over for discretionary spending every month.
For example, in simple terms:
Average monthly income: $10,000
Fixed costs: $7,000
Discretionary budget: $3,000
The final step therefore would be to make a list of all potential expenses. This would include any plans you have for the future. Do you want to open a second store next year? OK, add that to this list. Do you want to spend more on professional development? Go for it.
Remember—this is not a static budget. If you want to open that second location, you need to use money from your discretionary budget to fund that. If you see that you really should be spending more on marketing in order to create new business, then you are going to have to find the money in the above numbers to do that.
Maybe you will need to cut back on transportation costs and allocate that money to marketing instead. Or maybe you see that you are spending too much on labor, or too little on insurance. Whatever the case, by analyzing your overall income and expenditures (desired and actual), you will now be able to make smarter informed decisions.
After all, it is your budget–err, I mean plan–and you can use your money however you want.
P.S. Don’t Forget Your Emergency Fund
Before you wrap up this process, do not forget to add one more category to your expenditure list: Money for an emergency fund.
No, that may not have ever been part of your original business plan, but it should become part of your plan now. After all, one thing we know is that unexpected things can happen–pandemics, buildings catch fire, theft occurs, equipment needs replacing–and without a rainy day fund, all of your calculations, analysis, plotting and planning would have been for naught.
Yes, it might pinch a bit, but the bottom line is that future you will thank present you if you budgeted for that day.