A budget is an integral part of any small business. However, too many small businesses ignore the budgeting process and find themselves in a financial hole that they cannot climb out of.
This article teaches you how to create an effective budget while planning for best and worst-case scenarios.
For best results, download our small business budget template and follow along with the steps outlined in this article.
Free Small Business Budget Template
Why Do You Need a Budget?
The main reason you need a budget is that a budget will help you plan. Creating effective strategies to boost your income and lower your expenses is challenging when you do not have a reliable budget. Creating a budget allows you to understand the cause-and-effect relationship of your finances. Understanding these relationships will prevent you from overspending and help you plan for unforeseen problems.
How to Create a Small Business Budget
A five-step guide.
Step 1: Examine Your Revenues
The first step in any good budgeting process is to look back at your prior year’s revenues. When you are looking at your final numbers from the previous period, ask yourself the following questions:
- How consistent is my revenue each month?
- What is my monthly recurring revenue?
- What trends have I noticed in my business and industry?
- How much does my business grow each year?
- Do I have the capacity to grow my business?
- Will I be introducing any new products or services?
Use the answers to these questions to determine how much you expect your business to grow or decline over the next year. For example, let’s say you estimate your revenues will grow 5% this year.
From here, we will estimate a best-case and worst-case scenario. Admittedly, this is more art than science. But for this example, we will say your best-case scenario is 15% growth, and your worst-case scenario is a 5% decline.
The purpose of creating a best-case and worst-case scenario is simple to understand. Hope for the best, plan for the worst, and expect to land somewhere in the middle.
Step 2: Determine Fixed Costs
Next, we will add up all of your fixed costs. Fixed costs are any expenses necessary to your business that you will pay no matter what. Examples include:
- Rent
- Payroll
- Taxes
- Depreciation
- Debt repayments
- Subscriptions that add value to your business
In our budget, we will most likely conclude that these fixed costs will remain stable in our budget for the next period.
It is not necessary to create best and worst-case scenarios for your fixed costs.
Step 3: Determine Variable Costs
Variable costs are expenses you incur in producing your product or service. Examples include:
- Supplies
- Marketing
- Contractors
- Office Expenses
- Utilities
- Automobile Expenses
- Costs to Manufacture Goods
After adding up all of your variable costs, you must determine the relationship between your variable costs and your revenue. For example, you might spend 50 cents on variable costs for every dollar you earn in revenue.
So in our example of revenue increasing 5%, we can conclude that variable costs will increase by 2.5%.
In our best-case scenario, variable costs will increase 7.5%, and variable costs will decrease 2.5% in our worst-case scenario.
Step 4: Create Your P&L
This part is relatively simple. We will create a budget that shows our expectations, best-case scenarios, and worst-case scenarios. Then, simply subtract the fixed and variable costs from each scenario to find your budgeted net income.
Step 5: Compare Your Budget to Actuals
This is the most important step in the process. After the period is complete, we want to compare our budgeted report to what actually happened to find any significant variances.
We want to examine these variances to discover what went well and what could be improved in the next period. This exercise is instrumental in helping businesses eliminate excess spending and improve their budgeting process for future periods.
Conclusion
At Windstone Financial, we specialize in helping small businesses with all of their accounting needs. We have experience with helping businesses of all types plan for the future so they can successfully grow their businesses without any unwanted surprises. Click the button below to speak with a CPA today.
