Setting your small business budget for growth, profits and cashflow

Creating an effective budget is a fundamental aspect of managing any successful business. In this guide, we'll redefine what a budget represents—an empowering tool for growth, not a restrictive framework. Whether you're a small business owner or at the helm of a larger enterprise, understanding how to set a business budget is vital for achieving your goals, maximizing profits, and ensuring a healthy cash flow. 

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This roadmap will walk you through the essentials of setting a monthly business budget, highlight the importance of considering various economic and environmental factors, and introduce strategic steps to align your budget with your overall business objectives. Let's get started.

Budgets redefined

A budget is a plan of action to achieve your goals and targets set for your business. It also can be seen as a roadmap to lead you to your destination. This plan will include projections, targets and is to be linked to the various plans of your business (such as strategic plan and business plan).

What is not true of a budget?

A budget is not a restrictive tool that dictates what you can or cannot spend. It is not a limiting list of dos and don’ts. Instead, a well-crafted budget acts as a catalyst, helping you achieve your goals and targets. Unfortunately, budgets often get a bad reputation, diminishing their perceived power and impact.

Monthly vs. annual business budget

A monthly business budget focuses on each month’s plan of action. It outlines the plans and projections for various revenue, costs, and expenses. 

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The budget can be created for the entire year and then derived from the annual budget. It can also be done monthly, and then the annual budget is derived from the monthly budget.

What should you consider first when creating your first budget?

The first step in creating your budget is to set goals and specific targets for your business. These targets and goals are best set using the S.M.A.R.T. framework—Smart, Measurable, Attainable, Relevant, and Timely. However, goals and targets will be set outside of this framework, and this is okay. 

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Refer to your strategic plan and business plan to incorporate all the areas that build your overall business culture and standards, such as your mission, values, impact, and growth plan. 

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This step allows you to build targets aligning with your overall business direction. 

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For example, if your strategic plan identifies the target of expanding to multiple locations, your budget creation process will be clear and incorporate specific activities, sales mix, and focus to achieve this goal. 

The 4 steps to create your budget

Budgets are best created based on several factors/variables, such as:

• Environmental: what are the cycles and seasons that affect your business? What impacts the demand for your products and services? Government and industry rules, trends, fads, policies, permits, and regulations- what are the relevant ones that influence the operations of your business?
• Economic: The economy will always impact your business's performance. Factors such as interest rates, exchange rates, and inflation rates will affect your pricing, for example, and need to be considered when planning and creating your budget.
• Resources: As your business changes or strives to meet certain targets and goals, different resources will be needed. These can include skill sets, software, equipment training needs, and other resources.

Understanding the impact of these factors/variables and being aware of how they impact your business's operations will lead to enhanced decision-making and strategic moves that are greatly supported as you create your budget.

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The four steps to create your budget after you have considered all your plans outlined in our previous section will be as follows:

Identify your various sources of revenue 

Multiple sources of revenue should be identified. Your business may have several sources of revenue, such as sales, interest income, or investment returns. Within your line of business, there can be multiple sources of revenue. For example, you can own a plumbing business, and your various sources of revenue are services offered, sales of parts, and training other plumbers. You can find maintenance, rush jobs, or joint work with other companies within the numerous services. 

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The more detailed your budget lines are, the more understanding of your business lines and the potential to identify the revenue sources contributing to most of your sales. Again, this is important for planning and strategy as you create your budget.

Identify your direct costs 

What will directly affect the creation and supply of your products or services? Common costs are labor costs and materials or parts costs. Break down the various costs in detail. For example, labor costs are not only the hourly rate paid- it will also include payroll taxes, benefits such as health and dental plans and vacation benefits. This applies to your business if you have employees instead of contractors. So, dig deep and identify all those direct costs.

Identify your expenses 

These are also called overhead costs. They are usually allocated to other departments or cost centers in larger companies. These expenses are not directly related to the production or provision of your products or services; however, they are needed for the overall operation of your business. Some examples of these expenses are insurance, marketing/advertising, utilities, and donations.

Prepare your cashflow forecast 

A cashflow forecast outlines the sources of cash coming into and leaving your business. It is extremely specific when these cash flows will enter or leave your business. It differs from a budget in that it has the overall plans, and there may be differences in the timing of cash flows. For example, you may have plans to make sales of 15,000 in January, but due to payment plans, not all the monies for the sales will be received in January. The funds may be received over a 3-month period. The cash flow forecast will reflect this actual planned receipt of the funds (January to March), and the budget reflects when the sale is made (January).

Do small businesses need a budget?

Small businesses need a budget. Budgets are plans of action for your organization. Various types of budgets apply to cost control. Budgets are created based on the goals, action plans, and strategies the organization plans to execute. Having a plan of action that incorporates costs and timing for the required period will help to reduce overspending or spending that is not justified. Budgets also help to create a plan to ensure integral costs are not missed during planning, see more in Tips for better cost control and expense control‍. Budgets all help to identify money leaks, wastages, and operational inefficiencies, all of which are relevant to a small business. I believe all businesses of any size need a budget.

What is zero-based budgeting?

Zero-based budgeting is when your total income/revenue minus all your costs and expenses equals zero. This actually means all income is accounted for, and all monies that are projected to enter into your business are placed somewhere. 

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Every cost and expense are accounted for,, and there are no carryovers to the following period for amounts unspent. Each new budget is created from scratch, and all expenses are justified for each period.

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If you expect an income of $10,000 for the month, for example, you would allocate that income to the relevant areas such as savings, loan repayments, utilities, and so on. The entire $10,000 will be accounted for; the bottom line is zero.

What is the 50-30-20 rule, and how is it used?

This 50-30-20 rule suggests that 50 % of your income should go to your needs, 30 % to items considered wants, and 20% to your savings and any other type of debt. It is usually applied in personal/individual lives but can be used in business.

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Let’s say you get $10,000 in income after taxes. You would then allocate $5,000 to areas considered needs, $3,000 to areas considered wants, and $2,000 to savings and debt.

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In the business setting, it may not be smoothly applied depending on the type of business. If your business is a nonprofit or incorporated, the 50-30-20 rule can not be easily applied due to certain restrictions and regulations.

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It is can be very unrealistic or misleading since based on seasons and circumstances in your life it warrants rightly going against that breakdown of 50 30 20.

How do you budget with a small income?

Budgeting with a small income follows the process outlined in our previous sections.

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Additional steps would be to ensure that you weigh the pros and cons of your strategies, choices, income, and spending decisions greatly. 

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Consider the opportunity cost of your decision and seek creative ways to grow and achieve your targets.

How do you allocate a business budget?

Allocation is where costs that are not directly related to certain departments or specific areas of sales items are apportioned or spread (allocated) throughout your business to ensure all costs are spread throughout the organization appropriately throughout various departments. 

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How you allocate can vary- it can be done based on product sales, usage of various resources, or number of team members. For example, to allocate workers insurance, the total insurance is apportioned to various departments based on the number of employees in each department.

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A business budget is also used to plan how much revenue will be allocated to each department for the department’s specific programs and operations. For example, a total of $100,000 can be allocated to the business, and that total is spread throughout the business in various areas such as marketing, donations, or team events.

How do I make a budget spreadsheet?

The first step is to choose your spreadsheet tool, such as Microsoft Excel or Google Sheets. There is budgeting software and certain spreadsheets that can create your budgets automatically or even from certain cells being populated.

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Proceed to create your heading, which will be your company name, type of budget, and period of time the budget is for. Object display:

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ABC Company Limited

Total Budget

January to June 2024

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Depending on your business type and needs, major headings will be required. Common headings are Income, Costs of Goods sold, and expenses.

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Income

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Identify sources of income- sales of products or services, interest income, etc.

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Cost of Goods sold.

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Identify supplies, raw materials, labor costs

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Expenses

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Identify those expenses not directly related to production, such as marketing/advertising, utilities, etc.

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The final line will be the net effect, your profit/loss. From your income total, subtract the cost of goods sold and your expenses to get your net profit/loss. See extract below:

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Using your budget to grow your business and increase profits and cashflow

A budget is never utilized fully when created and then “shelved.” It is to be used actively in reviewing performance strategy and enhancing decision-making in your business. In my opinion, the budget process is incomplete after the budget is created; the budget process continues to use the budget in various ways(outlined below).

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Your budget can quickly identify nonproductivity, inefficiencies, money leaks, gaps in operations, and project cashflow crunches. 

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Using these tools allows the use of your budget for business growth to increase profits and cashflow:

• Variance analysis: Variance Analysis compares actual to budgeted results. Don’t miss this step in your budgeting process! It’s important to look deep into results and find out why budgets were achieved, surpassed, or not achieved. This process involves cross-checking and justifying results. It also allows for timely correction of errors in cost reporting and classification. This step allows for research and investigation as well as a deeper understanding of your business performance.
• Review: Crosscheck your budget against actual results in addition to your business and strategic plan at least monthly. Review areas such as sales growth, sustainability, risk management, growth plan, and operational efficiencies to quickly identify change strategies and decisions to be modified or made and be innovative and proactive.
• Key metrics: Using key metrics or indicators allows costs to be managed in relation to other results throughout your business. For example, labor costs can be examined in terms of your labor cost ratio. This allows labor costs to be compared to sales, which is a key measure of efficiency and quickly indicates improvements that can be made in scheduling, team dynamics, and training. Other key metrics are profit margin, gross profit margin, and growth rate.

Setting small business budgets

In conclusion, a well-designed budget is invaluable for driving your business toward growth, profitability, and optimal cash flow management. By redefining your approach to budgeting, you can transform it from a dreaded chore into a strategic asset that empowers your business. Embrace the positive impact of effective budgeting and watch as it helps you achieve your business objectives with greater clarity and confidence.

Track expenses with Ramp

Ramp simplifies financial management for small business owners by offering automation to track expenses and make financial operations more efficient. Ramp’s easy-to-use corporate cards, expense management controls, and accounts payable software ensure you effortlessly stay on top of your finances.

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