In 2021, 29% of new businesses failed because they ran out of cash, while 18% failed because of pricing and cost issues.
To avoid this common pitfall, effective budgeting is essential for your business. It’s one of those things that everybody knows is important, but it’s easy to forget about, and some can find the idea of financial management a bit daunting.
That said, budgeting is fairly simple when you break it down. This handy guide will tell you everything you need to know about the basics of budgeting in business, including:
- What is budgeting?
- Why is budgeting important?
- What types of budgets are there?
- How do I create a budget for my business?
What is budgeting?
Budgeting isn’t just cutting costs to save money. It’s a long-term spending plan based on your income (the money you earn) and your expenses (the money you spend). The idea is to have more coming in than going out.
To create a budget, you need to predict your income and expenses over a certain amount of time. Otherwise, you’re just guessing. If you can accurately forecast your budget, you’ll see one of three things:
- A surplus budget – you’re earning more than you’re spending, meaning you’ll make profits.
- A balanced budget – you’re earning the same amount as you’re spending, meaning you’ll make no profits or losses.
- A deficit budget – you’re spending more than you’re earning, meaning you’ll lose money.
Why is budgeting important?
A surplus budget is an ideal scenario – it means you’re profitable. And comparing your income and expenses can show you precisely what you need to do to increase your profitability.
But budgeting isn’t just about increasing your immediate profits. It’s also the best way to guide important business decisions, including:
- How to cut down on wasteful expenses.
- When you’re able to hire staff or buy new equipment.
- How to reduce your business debt.
- How to plan for future financial goals.
With a detailed budget, you can move forward with confidence and even use it as evidence when applying for loans or contacting investors.
Different types of budget
Your overall budget is called the “master budget”, and it’s made up of several smaller budgets. The master budget shows your overall financial performance, whereas the smaller budgets let you zero in on different parts of the business – see what’s working and what’s not.
The master budget is made up of these separate budgets:
- Operating budget – all of the income and expenses associated with your normal business operations. For example, the cost of goods sold and the revenue they create.
- Financial budget – a total of all your businesses long and short term financial obligations, including assets, liabilities, and equity.
- Cash budget – a record of the actual cash that’s moving in and out of your business.
- Fixed budget – any income or expenses that will stay the same throughout the year.
- Labour budget – how much you’re spending on employees wages and benefits.
By looking at each budget, you can better understand where your business is losing money, allowing you to make better financial decisions.
For example, your master budget might show that your budget is balanced, which is fine. But if you find on closer inspection that you’re losing money from fixed costs. In that case, you might be able to look for a cheaper alternative, pushing your overall budgeting into a surplus.
How to create a budget
First of all, creating an accurate budget for a new business can be tricky. Most budget figures are from past budgets, so if you’re starting from scratch, you might have to make a lot of estimates.
If that’s the case, look up similar businesses in your area and ask about their general expenses. After you’ve got your information, you can start to create different types of budgets using the following figures.
Consider all of the revenue you’re expecting to make for the year, then subtract the cost of the goods or services. The cost of the goods or services only accounts for things directly involved in producing them, like labour, materials, and shipping.
Even if you base estimated revenue on the previous year’s sales records, it’s always better to predict a conservative figure to avoid overestimating.
This is usually the easiest part of the budget. Anything you regularly pay for that’s unlikely to change can be recorded as a fixed cost. For example, building rent, utilities, insurance premiums, or employee wages are all stable costs that you’ll need to pay throughout the year.
Because they’re likely to stay the same, calculating your fixed costs is incredibly useful when budgeting because it gives you something concrete to plan around.
On the other hand, variable costs are things that could easily change. For example, the cost of an essential raw material might increase because of a sudden shortage, having a knock-on effect on how much you need to spend. This kind of variation is out of your control, so there’s not much you can do about it.
On the other hand, some costs can vary because of your business operations. For example, you might start producing a product on a larger scale. Larger orders from manufacturers are normally cheaper per unit, meaning your production costs have suddenly changed.
The second example is something you can prepare for, so planning ahead will allow you to properly adjust your budget.
One-time expenses generally fall into two categories, large purchases and unexpected expenses.
Large purchases are generally for something that will grow your business, like a new piece of equipment or a new location. You’ve most likely planned to buy something like this, so it shouldn’t be a problem as long as you’ve got the cash to pay for it.
On the other hand, unexpected expenses can have a devastating effect on your yearly budget if you’re not prepared. For example, you might have to pay for repairs to a crucial piece of machinery, or maybe you need to pay for solicitor fees to respond to legal action taken against you.
There’s no real way to predict unexpected expenses, so the best thing you can do is set aside a little every month as an emergency fund. If something happens, then you’re prepared. If not, you’ve got some extra cash lying around.
As mentioned earlier, cash flow refers to the actual cash flowing in and out of your business. It’s important to draw a distinction between cash and other valuable assets if you want an accurate picture of your current financial health.
For example, you can record things like property, accounts receivable, and inventory in your books – all these things have value. But even with all those assets, if you have no actual money, you can’t fulfil short-term financial obligations like payroll or monthly fees.
In that case, a business can go bust even though it’s profitable on paper.
Many businesses go through peaks and troughs when it comes to cash flow. Understanding where those are for your business will let you know when it’s a good time to expand and when it’s time to tighten your belt.
Finally, it’s everybody’s favourite part of the budget – profit.
You can find your profit figure by subtracting your expenses from your revenue. The amount of profit you project for the end of the year is how much you’ll be able to reinvest in your business, allowing you to make long-term financial decisions.
When you reach the end of the year, it’s important to compare your projected profits to the actual number. If you were off by a fair amount, it’s a good time to review each part of the budget and see where your predictions were wrong.
Reviewing the budget like this every year will help you make better, more accurate predictions moving forward, allowing you to plan further ahead.
Manage your budget with accounting software
A large part of budgeting is about having the right financial information. To make things a whole lot easier, try using a current account that gives you all the information you could ever need.
Countingup is the business current account with built-in accounting software. Receive live cash flow insights and create profit and loss projections based on your income and expenses, so you can handle your budget and plan for the future with one simple app.
Start your three-month free trial today.
Find out more here.