Whether you’re starting a new business or have been running your business for a number of years, it’s important each year to sit down and create a business budget.
Creating a business budget is important to allow business owners to understand their financial health and to manage cash flow. Planning each year by creating a budget can help you to understand your revenue, fixed & variable costs, and ensure that they have enough money left for unexpected costs.
In this blog we’ll look at the benefits of creating a budget, look at the things you should include in your budget and how this will contribute to your business success.
What is a business budget?
A budget plan covers details of what money you expect to spend during a year, a plan of what and where you may spend this money and allow you to track progress against your budget.
Budgets don’t have to be fixed, they are projected figure and as things change in your business or through the year, you could adjust your budget plan in line with these changes.
What are the benefits of creating a realistic budget?
1. It will help you control your finances
Budgeting will help you to manage and run your company more effectively and to keep control of your business finances and cash flow. It will also help you understand the situations that will drive profit in the long term.
For growing companies that employ other people, it can help you and your team to:
- Improve communication by accurately providing data.
- Reward performance and improve habits and behaviour.
- Understand how to evaluate performance.
- Understand future business needs.
2. Set better and clear financial goals
As a business owner, budgeting can be a key way to set business and financial goals. A business’ financial goals are highly crucial to determine growth in the long run.
The data will help you monitor the performance of the business.
However, financial health and financial goals should not be the only part of your planning, you need to set goals for your business beyond just financial goals.
3. Create a flexible framework
Effective business budgeting can help in creating a flexible framework for your business.
Small business owners that learn how to budget, review and adjust based on their projected and actual figures are more likely to make their business a success.
Budgeting and reporting actual vs budget will help you make better and more accurate decisions. It will also help you to make decisions quickly.
With the help of a budget, you can understand what is happening and how it will happen and quickly understand when your business is going off track and be able to action to adjust any issues.
The process of budgeting will allow you to consider different eventualities and scenarios for your business. Flexible budgeting will help you identify the reaction and actions needed in business.
What are the key elements of a budget?
Estimating the sales you may make and the revenue coming into to a business can be difficult. If you’re setting up a new small business, then estimating revenue can be even more difficult without any historical figures to base your predictions on.
Once you’ve been running your business for a while, you should be able to estimate the sales you’ll be making in the next week, month or year more easily, based on previous weeks, months and years.
Many business owners tend to be inaccurate, due to overestimating revenue and having to borrow or top up cash to plug the gap in cash flow. You need to be realistic about projected revenue.
Budgeting future revenue will give you the ability to then compare actual income vs projected income. The better you become at budgeting and can align your projected sales vs actual sales activities, the easier it will be to maintain a healthy cash flow.
Estimating costs that are fixed can be the easiest to identify and account for as they are consistent, recurring expenses and that are necessary to run your business. Fixed costs need to be paid whether you make a profit or not.
Fixed costs examples include:
- Premises costs – monthly rent, rates, mortgage costs, utilities bills etc.
- Equipment costs - For service based businesses, you may need to invest in IT equipment. For a manufacturer you may need to purchase or lease machinery, catering equipment, furniture, or fixtures & fittings.
- Staff costs – costs of recruitment, salaries etc.
- Insurance – depending on your business type, thinks like professional indemnity insurance, employers’ liability insurance, public liability insurance and building or contents insurance.
- Professional fees – For example lawyers’ fees to create contracts, employment contracts advice on rental contracts. Accountancy fees for online accounting software, bookkeeping and tax returns etc.
- Sales & marketing – advertising costs, website costs, email marketing software etc.
- Finance costs – Often it’s necessary to take out business loans or finance to fund your start-up costs, so paying these back should be factored into your fixed cost monthly amount.
Depending on the type of business you run, will drastically affect your fixed costs. For example, a consultant working at home will have very small fixed costs, compared to a manufacturer that needs premises and equipment to make their products.
Estimating your fixed costs shows you the minimum money each month or year that your company needs to survive.
Variable costs depend entirely on the number of goods or services you need, make or sell and these will change continually.
Variable costs can include things like:
Production costs – For many businesses such as manufacturers, the cost of production is one of the largest costs. However, the larger the quantity you can purchase, often means a lower per product cost, so you should factor this into your calculations.
Staff wages – will be a fixed cost if you recruit permanent employees, however if you hire contractors or short term staff that you only pay for the hours they work then these can be classed as variable costs.
Delivery costs – For example postage and packaging and shipping costs. Again, depending on volume, you may be able to obtain better rates for larger volumes.
Other costs- things like office supplies, mileage costs, postage, printing etc. would also be classed as variable expenses.
At times, it becomes difficult to separate fixed and variable costs in a business as variable costs are more flexible than fixed costs. However, if you ever need to consider cutting costs and increasing your profit margins, you should look at your variable costs first.
To understand more about expenses you can claim in your business, download our Expense Guide. Claiming these expenses in your business can minimise your corporation tax and income tax bill.
One off costs
If you are starting a new business, then one-time costs tend to be more common. For example, costs such as purchasing initial equipment, furniture, moving costs, software costs, initial launch marketing costs such as creating a website etc.
If you’re incorporating your business, then the costs of incorporation need to be factored in. Company formation isn’t a huge cost - find out more about dns company formation services here.
Read our blog on business start-up costs for more information.
Track you profit and loss
Looking at your profit and loss will give you an indication of how well your business is doing. Your net profit margin is the money left after deducting your operating expenses, interest and taxes.
Having a profit and loss statement (P&L) for your business will help you to understand your revenue less all your expenses and business costs and will give you a great indication of overall financial health.
Manage cash flow
Cash flow is the lifeblood of all businesses. Many businesses fail simply because of badly managed cash flow.
You should produce a cash flow forecast and check your cash flow regularly (depending on your business type, look at it daily or weekly). Checking cash flow will help you to keep on top of unpaid invoices, track income and chase for payment to ensure your business has enough cash coming in at the right time to cover its business costs.
Businesses will never be static so you may need to revisit and adjust your budget accordingly to adapt to external changes and changes within your business.
You should always keep an emergency fund in your business to allow for unexpected costs and also to allow for any customers that don’t pay you on time. Many business owners ensure they have enough money in an emergency fund to cover three to six months of business costs.
What is the best budgeting method?
There are different types of budgets to use depending on your business, timeline or project.
Zero based budget: This is where you start with a clean slate each year and a zero budget and build a new budget each year based on information, needs and expectations.
Master budget: This covers budgeting and forecasting for the full year, with projections for the income statement, cash flow statement, and balance sheet.
Static budget: This is a set budget that stays static throughout the year irrespective of changes to external factors or company performance.
Flexible budget: This is where your budget varies throughout a year based on sales performance. Your fixed expenses will stay the same, but you change the budget based on variable expenses.
Rolling budget: You will add a new budget period at the end of the most recent period i.e., quarterly or monthly. This method means you always have a full 12-month rolling budget at any time. A rolling budget will take into account your actual accounts figures to help you to forecast the next period. Often this way of budgeting is more accurate as it’s based on actuals.
Incremental budget: This adds or subtracts from the previous year’s actuals. So, for example you would consider last year’s budget and decide to add on a percentage for price increases. This can often lead to inefficient budgeting and also encourages people to spend budget before a year end to ensure budget plus percentage for the following year.
Creating a budget for your business will take time, foresight and effort but it will be worth the time to ensure you maintain a growing business and don’t get tripped up by unexpected costs or cash flow issues.
A budget will also help you to account for seasonal trends, make allowances for unexpected events and understand the emergency funds you may need and make better business decisions.
For help and advice on budgeting for your business contact dns on 03300 886 686, or email on firstname.lastname@example.org.
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