How To Create An Annual Budget For A Small Business

Businesses need budgets. So how do you go about setting a business budget? What are the main things you need to put in? And what will it tell you? Bookkeeper, Emma Northcote-Green, takes us through budgeting 101.

Emma Northcote-Green – Managing Director, Fresh Financials

This guide is brought to you by Xero and our Xero partner, Emma Northcote-Green, because we share a passion for helping businesses everywhere thrive.

Small business budgets are empowering. They give you the knowledge and insight to eliminate wasteful spending and get to profitability faster. A well-planned small business budget will:

show you how many sales you need to cover costs
figure out how much money you can reinvest in the business
find out when you can afford to hire help

When setting a business budget, you need good numbers. Don't guess at what's coming in and what's going out. You could be making assumptions that just aren't true. Take the time to look into your accounts and dig out the real figures. It might sound like hard work but it's worth it.

Small business budgets are easier to make than you think

Budgeting has a lot of baggage. It sounds boring, complicated and even daunting. But there's no need to put it off. There are just three broad sets of figures to get your head around and they're really simple.

Setting a budget is part of becoming financially literate, and it's a vital skill. The better you can 'read' the figures relating to your business, the more successful you'll be. And you don't need to become an accountant to do it.

The numbers that matter when setting a budget

So, which figures are important for your small business budget? Fortunately you don't need to consider everything. These groups of figures clearly tell the story of your finances:

1. Profit & Loss report

This report tells you at a glance whether you're making money or losing it. To do that, you'll subtract your expenses from your income. To help you get started, download our free P&L template.

Income (revenue): How much money are you generating from sales of your products or services? It helps to break these into:

Recurring income: regular and reliable revenue from client retainers and contract work
Expected income: predictions of future income. This is a forecast of what your business is likely to earn.

Expenses (costs): How much money are you spending on business costs such as staff, raw materials and marketing? As with income, it helps to break these into:

Recurring expenditure: your monthly payments for rent, utilities, payroll and so on
Sundry costs: occasional payments for office supplies, client entertainment expenses and other items

It can be easy to overlook some of the costs of doing business. To help capture them all, consider thing like:

Depreciation: business assets, such as computers and equipment, lose value as they get older. That should be counted as a cost.
Overheads: make sure you don't overlook fixed costs such as rent or energy (eg, electricity, gas, transport fuel)
Payroll: the total cost of employing your staff – including insurance, taxes and benefits.
Debt repayments: regular outgoings to repay loans or other business investments

If you have more revenue coming in than costs going out, you're making a profit. If it's the other way around, you're making a loss. A loss is okay in certain situations but losses aren't sustainable over the long term.

If you make a profit, think carefully about what to do with it. Could you:

drive bigger profits by reinvesting in the business?
save money by paying down debts quicker?
keep cash in reserve to ride out future revenue dips (this is an especially big consideration for seasonal businesses)?

There are many ways to treat a profit and setting a business budget will help you decide on the right strategy.

2. Balance sheet

This tells you what your business is worth. It's the difference between what you own and what you owe. On the plus side of the balance sheet you'll find:

the value of the assets owned by your business, such as work tools or real estate
cash you have in the bank
invoices that have been sent to clients but have not yet been paid

All of these are business assets. On the other side of the balance sheet are your liabilities, which include:

expenses that have been incurred but not yet paid, such as bills from suppliers
taxes that are due to be paid in the near future
loans or other business debts that you have

The balance sheet shows your assets minus your liabilities. Get started and download our free balance sheet template.

3. Trial balance

A trial balance is another very useful accounting concept. It shows all your debits, credits, assets and liabilities on a single document. In other words, it represents the entire balance of your business accounts.

With all this information at your fingertips, you're ready to start setting a budget.

Creating your first small business budget

Now that you have all your current financial information in black and white, you can create a forward-looking budget. It will tell you how much you:

spend running the business
can invest to improve the business
can pay yourself (and any shareholders)

A budget will also give you a much better idea of what your cash flow will look like. This will help you avoid running out of money and getting into a tight spot with creditors. Your budget will also show you where you can make savings.

Testing different scenarios – what if…?

Once you have a basic small business budget, you can start playing with the numbers.

What if sales go up by 10 percent?
What if you lose your biggest client?
What if you negotiate lower rent?

You can try dozens of different variables here. Many businesses use this type of exercise to find out when they can afford to hire staff. You can too, by adding payroll to your costs and seeing how that affects your profit.

You can create several versions of the budget to cover many variables. Experiment as much as you like and see what the outcomes look like.

An option for painless budgeting

Now that you know how to go about setting a budget, there's nothing stopping you from getting started – except, perhaps, the effort. Sifting through financial records to pull the data you need can be gruelling. Even so, it's best to avoid shortcuts such as estimating costs.

If you're looking for a quicker and less error-prone way to build a small business budget, consider accounting software. When set up right, an accounting system will automatically record all your income and expenditure so you don't have to manually gather the information.

Smart software can also show your income and expenditure in graphs and charts. That makes it much easier to spot trends and see how your business is performing.

Don't be afraid to ask for help

Setting a budget isn't complicated but it can still help to involve an expert. A bookkeeper or accountant can double-check the numbers and help you make realistic predictions about business growth, upcoming expenses, and tax exposure. They can also advise you on what to do if the actual numbers deviate from the predicted ones.

Bookkeepers and accountants charge for their time. But when it comes to business budgeting they will often save you far more than they cost. So if in doubt, ask one for help.

Budgets put you in control

The real advantage of setting a budget is that it helps you make strategic business decisions. Not sure what's going to happen over the next six months? Try a variety of different scenarios and see what numbers emerge.

Having a budget also means you're able to seek finance. So if you find you need a loan for something, you have everything you need to go and apply for one right away.

But most of all, a budget gives you more certainty and confidence. You get a clearer picture of the state of your business and you know where you stand. It's like turning on a light in a dark room. You'll be able to see the obstacles and find your way around them.

And always remember that a small business budget isn't set in stone. As your situation changes, you can make changes to your figures and see what it means for your profit.