How To Create a Business Budget in 6 Steps

Tom
Tom June 2022 Content Creator 13 min

Table of contents

A good business budget will assist you in many crucial ways. Each decision you make will be far more financially informed, forward thinking, and growth-minded. Your business budget can help you take advantage and capitalise on the busy seasons, and teach you how to cut down during the tougher months of the year. It will show you what’s working and what isn’t, and what you can do about it. 

Creating a useful business budget takes careful forward planning and a sober approach to business growth. One way to do this is to lay out the process in a series of steps. 

In this blog post, we’ll take you through the business budget in full. We’ll explain what it is and why it’s important, before we lay out the components of any complete business budget. Then, we’ll outline the six necessary steps towards business budget creation. 

Your business budget in a nutshell

  • A business budget is a spending plan focused on your company
  • Creating a business budget will allow you to grow your company in a confident, well-researched way
  • Within the business budget are many different types
  • The master budget comprises all the other budgets
  • The operating budget determines your daily operating expenses
  • The cash budget assesses your company’s cash flow
  • The labour budget determines hours required and labour categories for certain tasks
  • The static budget is a fixed figure that cannot be exceeded during a time period or until a project is complete
  • The first step towards business budget creation is conducting revenue estimation
  • Subtract fixed costs like utility bills, and determine variable ones throughout the year
  • Create a profit and loss statement to understand your company’s past, and use it to inform its future when outlining your business budget

What is a business budget?

Think of your business budget as a spending plan that is focused entirely on your company, small business, or entrepreneurial activities. Whether running your own business, working as a freelancer, or managing a side hustle, everything you do for work for yourself should be managed carefully with a business budget. 

Why create a business budget?

The reason you should create a business budget is the same as why you would budget in your personal life: to manage your finances properly and live a life with reduced stress in regards to money. 

Beyond the reasons outlined above to do with intelligent decision-making and business success, creating a business budget will also balance your mental health. Financial stress is a huge catalyst for mental health problems and, while not only affecting your relationships and daily life, this can also endanger your business. Budgeting means taking care of the problems that will cause stress, before those problems arise. You are prepared to deal with the problems, small and large, before they become problems at all. 

Which types of business budgets are there?

When you have put together your business budget, it will comprise inputs from other budget types. The point of this is to develop your budget in mind of many different aspects, covering all potential expenses and profit areas. 

Let’s take a look at each budget component in detail: 

Master budget

All the below budgets contribute to the master budget. As a central planning tool, your management team will use this to direct business activities and judge the performance of the business in various areas. Once all budgets are brought into the master budget, funds can then be allocated to achieve overall desired results for the business. Think of your master budget like the culmination of all your other budgeting. 

Master budgets are generally participatory, including contributions from other staff members and employees. However, you may choose to handle it yourself or restrict input to senior management. 

Master budgets are usually presented in an either monthly or quarterly format, displaying expenses over the fiscal year.

Operating budget

Determining your operating budget means projecting revenue expectations and offsetting those with expenses. In other words, how much will it cost to achieve the things you want your company to achieve? If a flower shop wishes for a 10% customer increase in the coming year, flower stock deliveries, staff wages, and other expenses are then required to meet this goal. 

Your operating budget should comprise the following categories: 

  • Revenue
  • Variable costs
  • Fixed costs
  • Non-cash expenses
  • Non-operating expenses

Begin putting together your operating budget by, collaboratively with other managers, agreeing upon a revenue estimation. Then, have input from managing staff to estimate expenses for the coming year required to meet this projected revenue. 

Cash budget

Here is where you estimate the cash flows of your business for a time period, e.g. annually. Cash flow being the money flowing in and out of your business due to everyday operating activities, what you want to determine with this budget is if the cash flow in your business signifies a stable financial situation over time. Cash flow will determine the reliability of your business from a financial point of view. 

Cash budgets can be measured both as short term and long term:

  • Short term cash budget: focused on utility bills, payroll, supplier payments, operating expenses
  • Long term cash budget: focused on tax payments, capital expenditure, long term investments

A cash budget with both long and short term considerations will give a much clearer picture of the state of your company’s cash flow, and ultimately of its financial stability overall.

Labour budget

While your operating budget determines the money needed for certain operations, your labour budget uses units of time (commonly in hours) to measure the labour required for results. 

For example, since a restaurant is a labour-dependent type of business, increasing patrons by 10% will require an analysis of the labour needed: bartenders, chefs, waiting staff, and kitchen hands will all need to have their hours assessed to reach the goals you have put forward. 

This would be an example of a more complex labour budget, because you are breaking down the information by labour category, i.e. which employee is performing which task. A direct labour budget is more suited to production line work, in which a number of items produced is proposed, and the hours required to make those items are calculated. 

It’s also important to draw up an appropriately detailed labour budget so that you are not overworking your employees or miscalculating wages and causing later problems with payroll.

Static budget

Your static budget differs from most other types. Instead of changing and adapting the way a cash or operations budget does, the static budget is to remain unchanged until the period is over or the project is complete. 

For example, budgeting for a traditional marketing campaign you might assign a €5,000 budget for a TV advertisement. It is then up to you and the marketing team to adhere to this budget, regardless of how the costs play out during the completion of the project.

Static budgets are popular among non-profit and government organisations because they have fixed incomes relying on grants or donations, and generally do not have reserve fund pools to dip into. 

Compared to flexible budgets, static budgets encourage discipline in spending on projects and clearly monitor sales and revenue. This is because if the budget is never exceeded, the numbers are clear. It’s also useful for reaching future financial goals for your business, when the funds required are kept in check due to static budgets. 

Financing can also be simple! With Penta you can find business loans from €1,000 to €250,000.

What does a business budget consist of?

To further break down your business budget, let’s now take a look at the existing components of a generic budget. So while your business budget is made up of the above budgets, those budgets each contain the below components.

Estimated revenue

Your estimated revenue is the total gross income your business pulls in over the selected time period. This differs from profit because, to determine profit, you subtract expenses and production costs and count what is left. A revenue estimation is crucial for your business because it helps you to understand in the future how much you can spend on production costs, rather than just how much your business earned that year. 

Fixed costs

A fixed cost is an expense that will always exist regardless of fluctuations in your revenue. These contrast with variable costs which do change because they are directly related to production and sales numbers. Another name for fixed costs is ‘overhead’. 

Fixed costs include:

  • Rent and mortgage payments
  • Utility bills
  • Insurance
  • Loan repayments

Variable costs

As mentioned above, variable costs fluctuate because they depend on business output. Your variable costs inevitably alter as cash flow fluctuates, depending on revenue one year or month to the next.

Variable costs include:

  • Raw materials
  • Piece-rate labour
  • Production supplies
  • Packaging supplies 
  • Payment card fees 

One-time expenses

Usually large expenses, a one-time expense is a non-operating expense. This is because operating expenses are day to day costs and generally arise again each day or month. 

Ideally, your business will not incur one-time expenses regularly. Given that a one-time expense is something like an office relocation, you ideally don’t want to be doing this on a monthly basis. 

One-time expenses are not generally included in the calculation of operating income. 

Cash flow

Cash flow is the circulatory system of your business. The flow of money in and out of the business clarifies for you the health of your business and is one of the most important financial assessments you can make. 

Including a cash flow assessment in your budget will mean taking a look at previous financial records to better inform future decisions. You should look at the following fluctuations when assessing cash flow:

  • Seasonal highs and lows
  • New products/features released
  • Changes in operations
  • Investing and financing returns

Profit

Determine your profit by first calculating your business’s gross total income over an annual, monthly, or quarterly basis. Then, once you have the number, subtract expenses and production costs and you will be left with profit:

Total revenue – expenses + production costs = profit

Profit will be referred to as ‘net income’ on your income statement and is commonly known as the ‘bottom line’. Calculating both profit and revenue will help you to understand both how well your business is performing during a certain time period, and how much it is costing you to perform at that rate.

Create your business budget in 6 steps

With those key definitions out of the way, it’s time to put together your business budget. The below steps will revisit the above definitions with instructions on how to implement them into each of your budgets, and ultimately put together a comprehensive business budget. 

Estimate the revenue

Revenue estimation is simply calculating the amount of money your business is likely to earn. Based on goals and resources, it is what you determine to be a likely figure you will see at the end of the proposed time period. 

The standard way most companies calculate revenue is by reporting net revenue instead of gross revenue. The difference is that while gross revenue is the money your business brings in overall, net revenue is that figure minus expenses.

Calculating revenue overall is done with the following formula:

Units sold x average price of each unit

And: 

Customer total x average unit price

Subtract the fixed costs

With your revenue determined, you’ll need to subtract the fixed expenditures throughout the time period from that number. As you’ll remember, fixed costs are things like utility bills, licences paid for, and relocations. Subtracting them will clarify your business’s performance outside of these infrequent and unavoidable costs. 

Determine variable costs

Increasing sales comes with increasing costs. This is the reality of the situation and it’s how we can understand the importance of variable costs. As your business grows, so will your need for things like raw materials, packaging, and the amount of fees on credit card transactions. 

To determine your variable costs, collect the following figures and numbers:

  • Variable cost per unit (the labour, materials, and any other resources required to produce your product
  • Units produced (the total number of units produced by your company

You then determine your total variable cost with this formula:

Cost per unit x times total units = total variable cost

You can also determine the average variable cost (AVC) if you have several different products with different prices. Do so by dividing the added total variable costs (TVC) of the different production units and dividing it by the total number of units. Here’s the formula:

TVC of unit A + TVC of unit B ÷ Total number of units made = AVC

Create a fund for unexpected costs

Your unexpected costs, also called your emergency fund or your rainy day fund, is what you’ll draw on if something unexpected, sometimes devastating, happens that will affect the financial stability of your business. 

This kind of event could be anything from a market crash or recession to an environmental disaster like a flood that damages your office or a storm that destroys a shipment of products. 

Secure the necessary insurance on these kinds of happenings and decide how much to put away each month for it. 

Create your profit and loss statement

A profit loss statement is a type of financial statement summarising the above information: revenues, costs, and expenses. With this, you can assess your company’s financial performance and identify where to either cut costs to boost profit or increase production. 

This example of an Amazon company profit and loss statement is an ideal layout of how to present your profit and loss statement. 

Outline your forward-looking business budget

With the above P&L statement offering a clear picture of your business’s past performance, you can now assess it to create a budget that looks towards the future.

Examine your P&L for these types of fluctuations:

  • Expensive equipment purchases causing financial setbacks
  • Seasonal trends that affect sales
  • Holiday periods and days that increase or decrease business performance
  • Unexpectedly high turns in profit with no obvious explanation

From these findings, you can begin to make forward financial projections based on previous occurrences. There will be some unknowable periods of profit and loss in the year—such is the nature of business—but you will be able to surround these with confident decision making and conserve during the tough months and bank on the good ones. 

Conclusion

Your business budget is your personal business cheat sheet. With past analysis and informed financial predictions, you can manage your business in a self-assured and clear-headed way. The only requirement is to construct your business budget patiently, inform yourself on each of its components and how they fit with one another. 

Hopefully, this post has clarified the components of the business budget and clearly laid out how to approach creating one yourself. Ultimately, the best way to learn about a business budget is to learn by doing. Time to get budgeting!

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