What is a Business Budget and How to Create it For Your Business

Introduction

Whether a small enterprise in the growth phase or a larger profitable company with revenues in the millions, every business needs a robust business budget in place, to ensure it uses its precious dollars in the best way possible. A budget plan identifies where money is spent and how much needs to be saved to meet financial obligations. This helps businesses make informed decisions.

In fact, a recent survey by American Express states that nearly 79% of small businesses are wary of increasing inflation, and 68% of them are worried about commodity prices. The only way to navigate such challenges is to create a dynamic budget that not only maximizes revenues but also fortifies businesses from sudden downturns. 

This blog discusses everything you need to know about a business budget- what it is, its components, its significance, the steps to create it, and how to navigate challenges relating to a business budget. 

What Is A Business Budget?

A business budget refers to a business’s spending plan based on its expenses and income. It helps identify the available capital, estimate expenditures, and analyze revenues. A business budget acts as a benchmark to set financial objectives and helps handle both short and long-term hurdles. 

A business budget considers accounting figures for past months and helps businesses make accurate projections for long-term financial performance. If a business has had poor cash inflow for the last few months and now predicts another month of poor financial performance, they can strategize and implement initiatives to cut down expenses and enhance inventory turnover to increase cash influx. As a next step, the business can focus on acquiring customers and making smarter investments for better returns. 

Why Is A Business Budget Important?

A business budget helps companies ensure efficient allocation of financial resources, track variances and adjust spending to increase available reserves and revenues in the long run. It is especially important for small businesses to budget, as it helps them identify when they need to raise finance, where to invest for more returns, gaps in cash flows, and more. Here are a few more benefits of preparing a business budget:

Different Types Of Business Budget

There is no one-size-fits-all method to create a business budget. It depends on the nature of the business and its financial structure. The different types of budgets used by businesses are: 

• Master budget
• Cash flow budget
• Operating budget
• Static budget
• Balance sheet budget 

• Master budget 

  A master budget consolidates budgets from various functional departments within a business, providing a holistic view of its financial activities. It includes components such as sales, assets, income streams, and operating expenses. Companies use this data to frame financial objectives and evaluate overall financial performance against individual departmental goals. Master budgets are primarily used by larger companies with multiple product lines and divisions to keep all departments aligned. 

• Operating budget 

  An operating budget helps forecast and analyze anticipated income and expenses over a period of time. However, to get an accurate view of their financial position, businesses must consider factors like sales, labor costs, material costs, production overheads, manufacturing, and administrative expenses into account when preparing an operating budget. Businesses can compare findings from budget analysis on a month-on-month basis to identify occurrences of overspending on supplies. 

  For instance, a manufacturing company can use an operating budget to plan production costs, raw material procurement, equipment maintenance, etc., to enable resource allocation and production optimization. 

• Cash flow budget 

  A cash flow budget helps predict how and when cash flows in and out of a business within a given time-period. It helps a company determine the available cash reserves and strategize effective cash management strategies. A cash flow budget includes factors like accounts receivables and payables to determine if a business has enough cash to meet operating expenses and how it can increase surplus in the near term.

  For instance, a consulting firm will use a cash flow budget to manage client invoicing, overhead, client invoicing, etc., ensuring sufficient liquidity to support ongoing operations.

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• Static budget 

  A static budget analyzes revenues and expenses that will not change throughout the year. Businesses use static budgets when they want to meet financial goals and streamline core operations despite changes in sales. Nonprofit organizations (NPO), government bodies, educational institutions, mostly use this type of budget.

  For example, an NPO can use a static budget to allocate funds for program expenses or fundraising activities to fulfill its mission, irrespective of cash inflow sources.

• Balance sheet budget 

  A balance sheet budget is used to identify and analyze a business’s assets, short-term and long-term financial obligations, cash and cash equivalents, investments, and other balance sheet items. It gives an overall idea of a business’s liquidity and helps companies find out how much capital they need to cushion short-term and long-term funding. 

  For instance, an SMB can use a financial budget to estimate revenue, expenses, and capital investments and make better borrowing decisions. 

Components of Business Budget

Businesses don’t have to include all parts of financial statements in their business budgets. Here are six key components of a business budget:

• Estimated revenue

  Estimated revenue refers to the forecasted total sales amount, that is, the cash a business anticipates from selling its goods and services over a time-period. Note that this is not a profit estimate. Revenue combines all the sources of income before deducting the associated costs. 

• Fixed cost 

  Fixed costs refer to expenses whose amounts do not change over a long period of time. They include items like rent, mortgage payments, employee salaries, insurance premiums, internet services, etc. 

• Variable expense 

  It refers to the cost of goods and services, which fluctuates frequently based on a business’s growth trajectory and performance. Variable costs include the cost of raw materials, production expenses, logistics and labor costs, etc. For example, for a retail gift store, variable costs for materials such as gift wraps or carry bags will be higher during the holiday season. 

• One-time expenses 

  One-time or one-off expenses are the costs that a business can incur at any time throughout the year. Renovation of the office building, replacing broken furniture, subscribing to a service for a particular project, are some examples. Since one-time expenses are difficult to forecast, businesses must keep aside a portion of the reserve so as not to disturb the cash flow. 

• Cash flow

  Cash flow refers to the money that comes in and goes out of the business over a given period and is the lifeblood of the business. Including cash flows in a budget will help businesses find the answers to: 

  • How much money do they have right now? 
  • How much cash will they have in the next week, month or year? 
  • What actions should be taken to ensure they have enough cash for business?
  • What risks or unknowns could affect the business’s cash?

  

• Profit 

  The last component of a business budget is profit. If businesses want to focus on improving operational performance and cash flow, then they must use EBITDA (Earning Before Interest, Tax, Depreciation, and Amortization) as the profit figure in the budget since it includes the core revenue number after deducting operating and administrative expenses. 

  Similarly, if the goal of the budget is to improve the overall financial performance of the business, then they must consider PAT (profit after tax), as it gives a comprehensive picture of profitability. 

How To Create A Business Budget In 6 Steps?

To create a budget, businesses must analyze past income and expenses and decode the causes of fluctuations. Here’s how to create a budget in 6 steps: 

• Estimate and add revenue sources 

  The first step is to identify all the sources of income and calculate how much money flows into the business. When computing income, a business must also factor in: 

  • Sales from trade shows 
  • Consulting fees
  • Sales from brick-and-mortar stores

  However, businesses need to note that at this stage, they only need to compute revenues, not profit. 

• Calculate fixed costs 

  The next step is to identify the fixed costs. Businesses can categorize these expenses based on whether they occur daily, weekly, monthly, or yearly and then add them up. The total fixed costs are then reduced from projected income. If a business doesn’t have historical data for fixed costs, it can include forecasted figures. 

• Identify variable costs 

  Variable costs, especially those impacting day-to-day operations like shipping costs, sales commissions, travel expenses, etc., must be considered first. Businesses would also find variable costs that are not critical but help improve the overall operational outcome, like customer recreation, employee development, etc. These are also referred to as discretionary costs and are added to variable costs. The budget must aim to reduce variable expenses during lean months to prevent working capital erosion and plan discretionary spending during profitable months. 

• Include one-time spends 

  While occurrences of one-time spending cannot be predicted precisely, the business can still budget, plan, and allocate a portion of its reserves for such obligations that may arise throughout the year. Despite being one-time expenses, these costs often emerge as crucial to business and are often incurred to remove hiccups in operations.

• Create contingency funds

  A business has to account for numerous possibilities and scenarios when creating a budget. It can face repayment issues due to interest rate hikes or inflation. Or, demand for the product may plunge due to seasonal fluctuations or some economic downturn, thereby reducing profitability. Therefore, businesses set aside a portion of their resources to keep operations running smoothly, make timely payments for debts, and alleviate cash flow concerns.

• Compliance with industry standards

  The regulatory standards and governance for businesses keep changing throughout the year. For instance, the government may make changes to tax slabs that increase or decrease the amount a business allocates for tax. Or, the government may remove or levy subsidies on specific items used as raw materials across industries. These factors will determine the business budget, as they will directly impact operating expenses and profit margins. 

A business budget example

Let’s assume, ABC Consulting decides to create a business budget for the next 12 to18 months based on their historical data and anticipated client contracts. They forecast a 15% increase in revenue and expect to generate $2,000,000 in total revenue during this period. The expenses are.:

Based on the above, here’s what ABC Consulting’s business budget will look like. 

Tips To Create An Efficient Business Budget

Despite being essential to business performance, companies often face numerous problems when creating budgets. Issues such as erratic cash flows, deficits in numbers, missed financial objectives from previous budgets and forecasts, and lack of analysis, impact the accuracy of budgets. These can lead to adverse consequences such as endless debt loops , inadequate working capital and lower returns. Here are some tips to help businesses create an effective and efficient budget. 

• Ensure accurate cash flows 

  One of the most common problems for businesses is erratic cash flows. For instance, a budget might include more sales than expenses for a given month. However, a business would still need to pay overhead expenses before it realized the revenue from those sales. To ensure no expenses remain outstanding, a business would need to create long-term cash flows to prevent payment shocks. 

  An automated cash positioning system can help navigate cash flow challenges effectively. With customizable cash position templates, businesses get complete visibility across regions, bank accounts, and categories, allowing for precise analysis and planning of expected cash flows. By identifying accounts with low balances, businesses can proactively fund them to prevent overdue payments. 

  

• Ensure forward-looking forecasting

  Businesses must aim to create forward-looking forecasting for accurate budgeting. It should be able to answer questions like: 

  • How much do businesses need to run their businesses currently?
  • Can the business invest more to improve operations? 
  • Does it have enough reserves to pay stakeholders? 
  • What are the chances of getting into a tight spot with lenders or suppliers? 

  An effective way to solve this is to use AI-based AR and AP forecasting tools. Using customer-specific AI models for AR and AP transactions, businesses can forecast cash flows from accounts receivable and expected payments to suppliers and accordingly make debt or investment decisions. Businesses can also view expected cash flows and variance at individual invoice levels and gain visibility on the overall available reserves. 

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• Take into account different scenarios and possibilities

  One of the best ways to prepare for contingencies is to identify the scope of all possible scenarios. Businesses can try numerous permutations and combinations of scenarios to analyze the future position of their cash. What if the sales increase by 15%? What if seasonal fluctuations bring down customer demand? What if the floating rate of interest on debts goes up by 10%? This will help them allocate resources accordingly and make informed decisions. 

  Businesses can use scenario analysis tools to create what-if scenarios on top of base forecasts, build snapshots, and then compare all of them side by side. They can play with amounts, percentages, or timing of cash flows or Fed rates and then analyze the impact of each scenario on various cash flow categories. 

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• Leverage automated ML forecasts 

  Gathering huge amounts of historical data and then analyzing it manually is often a daunting task for finance teams. Auto-ML forecast models can help businesses create automatic cash forecasts and pick the best-fit method of forecasting, ensuring the highest accuracy. Moreover, for lower transaction volumes like tax or debt payments, businesses can easily import schedules and use spreadsheet formulas to generate cash projections automatically. 

Enhance Your Business Budget With HighRadius’ Treasury And Risk Suite

HighRadius offers a cloud-based Treasury and Risk Suite that streamlines and automates treasury operations, including cash forecasting, cash management, and treasury payments. We have empowered the world’s leading companies, like Danone, HNTB, Harris, and Konica Minolta, to optimize their cash forecasting accuracy, make decisions faster with real-time bank data, and reduce bank fees.

Our Cash Forecasting Module leverages advanced technologies such as artificial intelligence (AI) and machine learning (ML) and integrates with banks and ERPs to get AR/AP data, improve ML prediction rates, and enable treasurers to achieve accurate, real-time cash forecasting. Businesses can forecast cash into any category or entity on a daily, weekly, and monthly basis with up to 95% accuracy, perform what-if scenarios, and compare actuals vs. forecasted cash. 

Our Cash Management Module automates the reconciliation process between bank statements and internal financial records, reducing manual effort and errors and increasing cash management productivity by 70%. With our treasury and risk solutions, treasury professionals gain instant, personalized insight into their cash positions with unparalleled global visibility. 

FAQs

1) What is the average marketing budget for a small business?

A study by the Small Business Administration (SBA) suggests that businesses, on average, spend around 10.8% of their revenues on advertising. As a rule of thumb, B2B companies should spend about 2-5% of their revenue on marketing, and for B2C companies, it should be 5-10% given the need to reach more customer segments.

2) How to create a budget for a small business?

Creating a budget for a small business includes six to seven steps: 

• Estimating all sources of revenue
• Adding all fixed costs
• Identifying variable costs 
• Calculating one-time expenses
• Creating contingency funds 
• Identifying seasonal fluctuations and downturns, etc.
• Ensure compliance with industry standards 

3) How does budgeting help a business? 

Budgeting will help businesses ensure they are spending their reserves in the right place at the right time. Here’s why it is important for businesses: 

• Increase efficiency
• Achieve business goals
• Identify available funds and reinvest 
• Project slow months to avoid non-repayments of debts

4) How to budget business expenses?

Here are a few steps to be followed when creating a budget for business expenses: 

• Identifying and categorizing expenses
• Gathering and analyzing past expenses
• Setting long and short-term financial goals
• Creating a budget to plan expense for each category
• Identify and prioritize essential expenses

5) How to budget business income?

Here are the steps to create budgets for business income: 

• Determine expected sources of income
• Identify fixed and variable income
• Set financial goals to save for critical purchases
• Allocate a portion of income for essential expenses
• Establish emergency funds and savings
• Create provisions for taxes