How To Make A Lasting Budget For Your Business
The importance of revenue cannot be overstated for business survival and growth. But if you don’t manage the revenue once it comes in with a good budget, you risk losing money as quickly as – or even quicker than – you made it. Think of a budget like your guidepost through the business world. It looks at money coming in and money going out, directing cash flows as it goes. With that in mind, knowing how to budget is crucial whether you’re planning for the whole business, your department, or a project.
While you may not be able to stick to a budget 100% of the time, having it means you have a plan for your money. Just as you’d never begin a large project without some sort of execution plan, you need the same form of execution plan for your money – that’s a budget.
Why you need a budget in business
Creating budgets requires honesty with yourself and a bit of a time investment – luckily, it has a lot of upside potential benefit for the business.
Budgets help you stay on track
A study by Clutch found that over 60% of small businesses had no budgets. The study further found that the top financial worry for small businesses was unforeseen expenses – issues that could have potentially been avoided with a budget.
When you know how to budget, you know where your money is going. It’s something you do automatically anyway as a business owner, though at the start the numbers are probably in your head. By writing them down, you solidify your commitment to your priorities and can stay on track.
Budgets help you set goals
If you start with an ambitious desire in business, you’re going to need money to make that happen. If you forecast you’ll need $10,000 for marketing to make your products more successful, then a budget will show you where that money will come from and what you need to forgo.
On the flip side, if your budget falls short of that $10,000, you can make decisions about what to cut or lower in order to make up the necessary cash. If you can’t, then the budget offers a reality check that your goals may have been too much for the business at that time.
Budgeting makes your business real
It’s easy to make bold claims about how much you’ll bring in, but the process of budgeting puts all the numbers down in black and white (or black and red, really).
Budgeting makes you a better entrepreneur or intrapreneur
Because budgets are focused on real dollars and cents in the business, they will make you a better entrepreneur or intrapreneur.
Budgets teach you about money
The process of creating a budget will teach you more about money. As you use more budgeting software, you’ll gain both tech savviness and a digital understanding of money.
Budgets give you a financial visual of your company
It’s easy to get caught up in the day to day of running your business or your project – having a budget forces you to take a step back because it will encompass all the money flows in the organization.
Depending on your organization’s size the numbers may not be down to precise dollars, but having an overview will show you where the engine of your company – where you invest your resources – is driving towards.
How to budget with different budget categories and expenses
As you go into creating your budget, consider which type of budget is right for you.
Zero based budgeting
Zero based budgeting looks at the business from the lens of every expense having to prove itself.
When you use zero based budgeting, you get a clean slate every time. This means having a list of all your expense categories, then filling it in line-by-line with necessary items and their costs. Each item is up for debate and must show its value or it risks being taken off the budget.
How to budget with zero based budgeting
These kinds of budgets are best for very small, lean teams – or teams looking to cut costs and prove the value of each expense.
If you’re just figuring out how to budget, zero based budgeting may be a solid option for you.
You start by looking at every expense category in the business.
Having everyone on the team collect all expenses that relate directly to them. If the whole organization does this, you’ll get a clear snapshot of the company’s expenses.
Remove duplicates from the list (chances are there will be duplicate entries, especially for subscriptions multiple people in the company use).
Each item is debated for its value to the company, and only added to the budget if there’s value.
The problem with zero based budgeting
Be aware that zero based budgets have the power to both increase and decrease creativity in your business.
On one hand, people’s creativity is sparked because they have to justify their expenses and will likely be asked to do more with less. On the other hand, zero-based budgets can turn into a game of getting as close to zero as possible. If that happens, everyone will look for any reason to cut an expense instead of looking at the value it gives to the company.
To avoid a creativity decline, give your team some time beforehand to look at how each expense creates value for them. That way you avoid the issue of someone feeling pressured if they can’t come up with an answer on the spot – accidentally cutting an expense that provides value in a unique way.
Incremental budgets start with a certain amount allocated for a given area. After that, additional budget room needs to be applied for through a process (each company is likely to have a unique process.
How to budget using incremental budgets
Start out by identifying the “floor” for each area of the business. This could be determined by the previous years’ spend, the annual plan from leadership, or a specific commitment from the company.
Design and communicate the process for getting additional budget.
Let functional leaders determine how to spend their budget in order to achieve specific business goals.
The problem with incremental budgeting
Incremental budgeting is a great idea in theory because it gives functional leaders the freedom to do what they want. It targets a core problem of zero based budgeting that each item is up for debate, which can be exhausting and limit creativity.
However, incremental budgeting can cause complacency or laziness in the budgeting process. Since the process starts with budget floors, it can be tempting to just pick a random number or go off last year’s spend, even though times have changed this year. To avoid this problem, ask leadership to make their plans for the year and include a budget “floor” within them – that way you can get a gauge of how much the company is asking for.
The same process goes for project budgeting as well. If project managers ask for their “floor” and their “ideal” budgets, you can have a good conversation that, if done really well, won’t require any additional budget.
As the name suggests, draw-down budgeting is when you have a set number and then each initiative takes budget dollars away. You can do this in order of priority or in a first-come, first-served basis.
How to budget using draw-down budgeting
Identify how much you have to spend, either on a whole-company basis or a departmental basis.
Choose whether budget draw down will be done by priority or by first-come, first-served.
If it’s by priority, decide on a prioritization framework and communicate it out to leadership. If you’re doing it on first-come, first-served basis, then communicate when leaders can start making budget requests (note: this is not the recommended approach).
Continue the process until the budget is allocated for the time period, and then go about your business.
The problem with draw-down budgeting
When a budget starts with a big number, people will feel more free to make large budget requests even if they are not the best for the business. Unfortunately, this type of budgeting creates the mentality where people ask for big things up front in case they won’t be able to ask for them later.
To avoid this pitfall, shorten the time frames for the budget – to quarterly or monthly, not annually.
The second issue with draw-down budgeting is that it can become very political. Even with a robust prioritization framework, politicking at work could change who actually gets big dollars in the end.
Avoid this pitfall by making your prioritization framework incredibly clear and transparent so no one can politic around it.
How to budget between fixed and variable business expenses
When it comes to figuring out how to budget, you’ll no doubt have many expenses. Some will be big and others small, but you’ll need to categorize them into different types of business expenses.
That way you can more easily make financial decisions for the business based on how your money is being spent, not just the things you’re spending money on.
Fixed expenses are amounts that don’t change from period to period. Typically monthly or annually paid, a fixed expense is both comforting and your worst enemy in business.
When you have fixed expenses, it provides some comfort because you know what the number will be for each period. You’re done after you earn that amount in revenue. It can be especially comforting for businesses that have been around for a while and know their business model well.
But most fixed expenses also don’t stop when business goes down. So if you’re not doing as well as you’d hoped, you still have that fixed expense to pay each period. That can be a source of stress and anxiety for any business owner, so be sure to keep fixed expenses as low as possible.
The only kind of fixed expense that you would want to increase is any expense directly correlated to revenue – with positive unit economics. For example, if you had to pay $100 in fixed manufacturing costs to produce your product, but you already have recurring orders for more than $100, the fixed expense is worth it.
A variable expense can change each period, depending on key metrics. In most cases, for example with subscriptions and SaaS products, the key metric will be number of users or amount of usage.
Variable expenses can also provide some comfort because they are usually tied to success in business. For example, if you have to let go of staff because of tough times, you also lower any variable expenses related to them being at work such as health insurance or email addresses.
On the flip side, a variable expense also increases when you become more successful. It’s not a problem, per se, just something to keep in mind – that extra dollar of profit might actually cost you more than a dollar in variable expenses. With good unit economics planning, you can ensure that your variable expenses are always increasing at a rate less than your revenues.
The good thing about variable expenses increasing alongside success is that it opens up room for price negotiation at scale. You may not have been able to negotiate a bulk discount when you were paying for 10 staff subscriptions for a SaaS product, but you likely will be able to get lower per-person rates for 25, 50, or 100 subscriptions.
How to budget for other types of fixed expenses or variable expenses
While fixed and variable expenses cover every kind of expense, there are other ones worth highlighting.
Capital expenses relate to purchasing fixed assets such as land, equipment, or real estate. When you have a capital expense, it’s usually financed in whole or in part, meaning you will have a payment to make each month (or another arrangement).
Making capital expenditures should only be done if it fits into your business plan and is directly tied to revenue. In most cases, there are ways to mitigate capital expenditures through leasing or renting – and these options are typically much cheaper. The thing to be aware of with renting or leasing is that you will have to deal with a landlord or owner, which may not be desirable for every business.
Overhead expenses are expenses not tied to revenue generation. These can be fixed or variable, depending on how they work, and include:
- Legal expenses
- Government fees
- Overtime wages
Or anything else not directly tied to creating a product or service for sale.
How to budget for personal expenses in your business budget
When looking at personal expenses, it may be possible to put them on your business budget. There are a lot of legally expensable items for business owners or intrapreneurs doing a project within a company.
Education and coaching expenses
If you need specific professional development, such as a coach or online course, in most cases you can expense this against the company. If you’re going to do this, though, these expenses should be accounted for in your business budget.
Sometimes, these kinds of expenses happen in a more emergency fashion, for example realizing you are short on a necessary skill and can’t outsource it. In that case, these expenses might be covered by you out of pocket then reimbursed later. From a budgeting perspective, this would likely be called an emergency expense and calculated in the next budget if need be.
As an entrepreneur or intrapreneur, you may be able to expense some of your living expenses if you are doing work for the company. These things might include travel expenses for work, food expenses, and more.
These types of things, whenever possible, should be estimated and included in the budget in their relevant categories. If you can’t estimate the costs, then budget a slush fund – an amount of unallocated money that is earmarked to be spent in some way – so that your budget doesn’t get a shock when the expenses come up.
Budgeting software to help you learn how to budget
Almost every business would benefit from budgeting software, which gives you:
- Visibility into your finances and budget
- Data connectivity so you can see how different areas impact your budget
- Data security since it’s being held in the budgeting software and can be easily retrieved, shared, and recovered
There are a lot of budgeting software options in the market depending on your needs.
Offering payroll, accounting, invoicing, and more, Wave is focused on empowering small businesses and “solopreneurs”. Their core accounting platform is free, while other services like payroll and invoicing have fees attached.
Quickbooks is focused on helping small businesses and freelancers manage their money and find more tax refund opportunities.
Freshbooks is another accounting and invoicing software that focuses on task automation and easy usage so business owners can spend more time building their business.
A tried and true tool, tracking expenses in Excel is still a robust option. However, updates will always be manual and data could get out of date very quickly.
Budgeting tips, tricks, and things to keep in mind when learning how to budget
When making a budget, there’s a lot to consider. It can be a daunting process. To help streamline the process, there are little things to keep in mind.
Budgets are iterative
Don’t be afraid of going back to the document over time! This also means you don’t have to make your budget perfect the first time, either. There’s a lot that can change (it’s one of the reasons budgeting software can help you out)
Always set aside money for taxes
Even if you don’t think you’ll owe any taxes, set some money aside – a good rule of thumb is about 30% of your revenue if you don’t have an accurate tax estimation yet. That way you won’t be hit with any tax surprises.
Separate personal and business expenses
Unless the expense is part of the business budget – for instance executive travel for work – no personal expenses should make their way onto business budgets. This is especially important for small business owners or solopreneurs. It’s so easy to fall into the trap of combining them, but it gets messy for tax purposes if you do this.
Consider paying yourself a smaller salary and taking income elsewhere
One of the perks of owning your own business is the potential for a big paycheck. But it might be smarter from a tax perspective to pay yourself a smaller salary and take income from other means, like drawings or dividends. Talk with your accountants to see which avenue is best.
Keep ALL receipts
A big part of budgeting is estimating taxes and other expenses. One of the best ways to forecast is with real data – so keep track of all receipts (you can log them in your budgeting software for a digital copy). That way you can look at real numbers for your budget categories. It will not only help you forecast, but it’s crucial for staying on track to your budget and filing taxes later.
Automate payments that you’ve budgeted for
If you know the money needs to go out and it’s accounted for in your budget, make it automatic! Talk to your vendors about doing pre-approvals or routine charges. That way you can focus on your business – just be sure to get the receipt every time.
Don’t budget alone
Unless you are a solopreneur with no employees, don’t budget alone. Even then, involve your mentors and advisors to an appropriate extent. Doing it alone means you have a higher likelihood of getting caught in the weeds or not thinking of something else in your business. It’s not an insult – a business is a huge undertaking for one person to think of all the time.
Budgeting isn’t always easy, but knowing how to budget is worth it
When you make a budget, it can feel painful. You’re reducing your whole business or project to a series of expenses. But it’s a necessary process to give you financial clarity – after all, you are in business to make money.
Getting a grip on where your money is going by budgeting will help you set a clean foundation to grow from, financially speaking. Way down the road, too, good budgeting habits will come in handy – if you ever want to expand your business or sell it, clean financials give you the best chance of a good return on investment.
Images courtesy Unsplash.