For budding entrepreneurs and small business owners, budgeting is not usually at the forefront of the mind. Between the business ideas, products, branding and of course, the hard work, it’s easy to dismiss the importance of budgeting and financial planning.
The truth is, failing to budget is a potentially fatal error. This survey of some 80+ failed startups found that around 50% didn’t have a proper budget in place.
Whilst some 89% of startups last one year, only 42.4% progress beyond 5 years, according to the Official for National Statistics. It’s after the 1 year mark that cracks start to surface - cracks that can be avoided by creating a proper budget.
So what is a business budget, and how do you create one?
Put simply, a budget is a financial plan. Most people will have budgeted for something in their lives already, e.g. for monthly bills, a mortgage, to go on holiday, buy a new car, coat, etc. This involves saving money and monitoring cash flow to ensure the right sums of money are available to spend at the right time.
A business budget follows the same principle. It’s a means of projecting and tracking a business’s financial activity over a specific period of time, usually a month or year.
A simple budget typically covers a 12-month forthcoming period and will contain the following information:
Bank Balances and Business Savings
The first thing to look at is your business’s current balances. The self-employed in the UK are not required to keep a separate business bank account, but it’s strongly advisable that limited companies and limited liability partnerships use dedicated business accounts to separate personal and business finances.
Establish how much money you have allocated to your business already. This is the foundation of the budget and will also serve as the contingency fund. Keeping an adequate contingency and investment fund allows a business to scale up when it’s optimal to do so.
Many startups fail because the founders don't commit a large enough initial investment. Forecast immediate costs to ensure that initial investments are sufficient with some extra for overspending and contingency.
Analyse Income and Revenue Sources
Some businesses have steady cash flow, but this is not always the case. Many businesses pick up the majority of their business over just a few months. Work through each month's projected income over the forthcoming 12 month period. Calculate a monthly average of all revenue and income streams gained from invoices, sales and contracts.
Use revenue figures and not profit - business expenses will be deducted from the budget afterwards.
Budgeting for Business Expenditure
Once business revenue streams and income sources have been established, analyse ongoing average monthly expenditures to find average trading profits. Like revenue, business expenditure may fluctuate greatly throughout the year.
Common business expenditures include:
Deducting your expenditure from your revenue provides a rough monthly profit figure. Profit and loss should be recorded on a balance sheet that shows monthly revenue and expenditure broken down item by item. As the year progresses, you'll be able to compare your actual income and expenditure to your projected income and expenditure.
Budgets are invaluable for planning ahead. Once you’ve created a budget, the likelihood is that some months will project greater potential profits than others. Some months might show a loss. That’s the point of a budget - it helps avoid a situation where a business turns over a loss the same month as it has particularly high capital expenditure, thus crippling the business.
On the flip side of the coin, identifying and forecasting profitable months allows businesses to scale and invest when they have an excess of cash.
Budgeting provides valuable foresight into where a business is headed in the near future. For example, a business might expect the pre-Christmas period from September to November to be particularly costly with regards to purchasing stock, but the Christmas period from November to December is particularly profitable. Budgeting for that increased expenditure from late summer allows the business to ensure it has the money to invest in Christmas stock.
Businesses that plan to raise venture capital or attract investors will need a robust budget. Budgets help investors evaluate business risks, helping them forecast where their money will be spent and how it can slot into the budget. Obtaining small business finance is much more attainable for businesses with professional budgets and accurate cash flow forecasts.
Predict Cash Flow Issues and Bottlenecks
In the UK, around £67bn is owed to small businesses at any one time. Whilst some revenue streams are consistent and dependable, others are less reliable and this needs to be factored into the budget.
For example, relying on revenue from heaps of invoices the same month as you need to pay off a big debt or contract may not be a good idea. Predicting these sorts of situations prevents unforeseen cash flow issues whilst ensuring that a business’s contingency fund is able to soak up late payments.
Analyse Business Progression
Budgets help businesses analyse their progression. As a business’s forecast profits increase, the budget allows more room for a business to invest and scale. The opposite is also true; if a business is going through a rough patch then a budget helps plan cost savings.
Business finance and budgeting software can really speed up the budgeting process. Many allow businesses to create a budget for a set period of time, e.g. a month or year, and then compare their actual income and expenditure vs their projections. Some examples include Mint, Float, Scoro and Quicken.
Implementing a business budget provides insight into a business’s income and expenditure. So many startups and small businesses fail due to avoidable financial mishaps - budgeting is the first line of defence against unexpected financial issues.
Budgeting also provides peace of mind and helps business owners forecast and analyse their business progression. The generic business budgeting process outlined here is pretty simple and it can grow and expand as the business develops. Use budgeting software to simplify the process of budgeting - it’s well worth the initial outlay in time and effort!
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