What is budget planning?

Budget planning is simply the process of creating a plan to spend your money. It allows you to determine in advance whether you will have enough money to do the things you need or would like to do.

Budgeting helps you save money for the long term or when your business needs it most. If your accounting software doesn’t have budgeting features, it’s a great idea to use a budget calculator – a tool meant to help you establish a budget, create a savings plan and pay down debt.

“Budget planning involves looking at external (economy, regulations and laws, etc.) and internal factors (staff, revenue, expenses, etc.) and then estimating needs, incorporating unexpected things, developing future goals, and looking at historical information and trends,” said JeFreda Brown, CEO of Provision Financial Education.

How do you create a budget for a business?

Budgets indicate how much money is spent toward things like payroll, advertising, supplies and other necessities. To create a budget for a business, small business owners should look at revenue and expenses for the entire calendar and fiscal year. It’s important to look at what you spent the previous year, and then project if you will spend the same, less or more moving forward.

In budget planning, the goal is to lay out all necessary components and brainstorm your goals, according to Shahid Hanif, founder of Shufti Pro. Hanif named some steps the budgeting process should include:

1. Examine your revenue. The first step in any budgeting process is to look backward at your existing business and find all your revenue (income) sources.
2. Subtract fixed costs. The second step in creating a business budget is to add up all your fixed costs (like rent).
3. Determine variable costs. As you search for the data you need to list your fixed costs, you might notice some variable costs within your business as well, such as costs for labor or raw materials.
4. Set aside a contingency fund for unexpected costs. Whether you’ve run a business before or not, we all know that these expenses don’t come when it’s convenient.
5. Create your profit and loss statement. Once you’ve collected all the above information, it’s time to put it all together to create your profit and loss statement, or P&L.
6. Outline your forward-looking business budget. Whether you’re a new business or you’ve been doing this a while, projecting what will happen to your business in the future is educated guesswork.

It’s best to categorize your budget by fixed expenses, variable expenses and non-necessities. Fixed expenses stay constant, regardless of the number of sales, according to Axel DeAngelis, founder of NameBounce.

“Generally, fixed costs are contractual,” DeAngelis said. “An example of a fixed cost is rent. Unless your business pays percentage rent based on sales, the rent is generally contractual, with fixed increases throughout the life of the lease.”

Variable expenses can include some bills or software, as business owners tend to have more control over these expenses and they fluctuate based on sales. DeAngelis gave sales team commissions as an example: If your business were to sell 10,000 products, you would pay your sales team more in commissions than if you sold 100 products.

Non-necessities are expenses such as travel, entertainment or office perks like a flavored water cooler. This category usually does not include monthly expenses your business needs.

What information do you need to create a budget for a business?

Budgeting for business should include any and everything you will spend money on during the fiscal year. Failure to use a budget for your business can be a missed opportunity to meet your financial goals.

According to Ken “Mr. Biz” Wentworth, founder and “on-demand CFO” of Mr. Biz Solutions, it’s crucial for business owners to analyze and include these four key pieces of information when creating a business budget:

1. Revenue: For revenue, you must first establish your annual goal, then use your historical actuals to determine how to accurately distribute your annual amount across the 12 months.

2. Cost of goods sold (COGS): Once you’ve established your monthly revenue budget, you use those numbers to drive your COGS budget. Again, use your recent historical percentages to determine each COGS line. You simply determine the average percentage for each line based on monthly revenue projections. 

3. Overhead costs: For this step, review your most recent year and adjust as needed. For example, you can start with a baseline of last year’s actuals. From there, adjust reflected activity for the budget year – eliminate nonrecurring expenses from the baseline year, make additions for known one-time expenses in the budget year, make reductions for known savings, etc.

4. Margin review: To ensure your new budget will help you accomplish your goals, you need to review your margins. Review your gross margin percentage and net margin percentage. What are your goals for those two measures? Whatever they are, you need to ensure the new budget you just created reflects those goals. For example, if you want to improve your gross margin from 52% to 55%, ensure your budget equates to a 55% gross margin. If not, tweak your COGS numbers to get there. This will set the budget baseline that you will use to measure your business’s performance.

What are the three basic budget categories?

A business budget should include all your business’s current revenue and expenses. This budget should also include estimated or projected revenue and expenses. Brown listed three basic budget categories:

1. Operating budget: This is the annual budget that the company will follow to meet its financial goals.

2. Capital budget: This is a budget developed when the company plans to invest in fixed assets, like new machinery.

3. Cash budget: This is a budget developed to help company leaders estimate future cash needs and to plan for emergencies and future investment opportunities.

How is planning different from budgeting?

Business planning and creating a budget for business are closely related but established with different goals in mind. Hanif says that planning is usually the first step in setting up a small business and continues to be used as a workflow progresses.

“Planning could be something simple, like building your daily agenda, or long-range enough to envision where you want to see your business in five or 10 years, whereas budgeting determines how existing financial resources are allocated,” he said. “Budgets are usually set by how previous money was spent and expected income.”

Preparing a budget can be a difficult task, but once you do it, you’ll have a much better understanding of your business and be able to plan for the profitability you’re looking for. If you stick to updating your monthly budget, your annual budget will become easier to create and more accurate. When you know where your company stands financially, you can make better decisions to help your business be profitable and successful.