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FINANCIAL LITERACY •  23 JULY 2021 • 4 MIN READ

How to set a budget

How to set a budget

We’ve written before about what a budget is.  This article aims to provide you with a detailed guide to setting a budget and understanding the drivers of your business.

Why you need a business budget

When running a business, creating a budget is one of those things that can fall by the wayside. If your business is operating with a significant amount of profit or is going through a boom, it might not seem important to create a business budget.

But a budget can help the long term success of your business. This is not just limited to the year to come but can help you plan for the three, five or longer term goals of your business.

Where to start – budgeting your income

Examine your revenue

First thing first is to look at your historical revenue and find out all the sources of your revenue. Once you’ve identified all your revenue streams, you can begin to calculate your monthly revenue.

Usually, revenue in a business is based on a quantity. For example, income for a fruit and veggie shop might be the quantity of produce sold. Revenue for a design agency might be the quantity of hours billed. When budgeting your revenue, think about what is driving that figure. It is a good idea to break your revenue predictions down into their building blocks of number of items sold, because that gives you a clearer target to measure, rather than just total dollars per month. 

Remember to think about things like seasonality (when you will sell more or less in the year), holidays, annual closedowns and such. If you’re going to budget for an increase in revenue you’ll also need to think about what effect that will have on your costs. Will you need to pay staff more hours to get more sales? Or will you need to purchase more stock to sell, to increase your sales?

Other income

Think about any grants or subsidies you might be able to apply for. You’ll also want to include in this section any interest income if you have cash on deposit, or other income streams such as subletting office space or honorariums.

What’s next – budgeting your costs

Direct costs

Direct costs are those which are directly tied to the production of specific goods or services. These costs are either fixed, such as rent for the production facility or the salary of the production supervisor, and those that are variable, such as the cost to purchase each individual item you sell. 

Any cost that's involved in producing a good, even if it's only a portion of the cost are included as direct costs. Some examples of direct costs are listed below:

  • Direct labor
  • Direct materials
  • Manufacturing supplies
  • Wages for the production staff

If you are in the business of providing services, direct costs may typically include salaries paid to the professionals delivering the services. 

Overheads

Finally, let’s cover overheads. Overheads are those costs which don’t directly relate to each unit of sales, such as the electricity cost of running your premises, marketing, insurance, rent for your building, or subscription costs for industry memberships. Generally, most if not all of a business’ overheads are fixed. That’s because they don’t usually change much depending on how many units you sell.

Tax

In a company that turnover less than $50m per year, tax is charged at 25% of your net profit. When preparing a budget it is good practice to include this in each month as a final expense. Perhaps some months in your budget show a loss – then you could budget your tax that month as a positive figure. Because this isn’t reflective of actual cashflow you can also just include it as a total of the year in the final month of your budget if that is clearer for you. It is important though that tax is included as part of your budget as it is a cost to your business.

Depreciation and Interest

It’s easy to forget these two line items but if you have a loan, make sure you include your interest expense. If you have fixed assets or equipment to help run your business, there will be depreciation on those items. Your accounting software will be able to help you project out these expenses.

Accountants are the best at actively working to make sure you’re not paying any more tax than you need to. So, often what you would budget in tax would be different to what you would end up paying once our team has completed their work.

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Other items

Buying assets and paying back loans

It’s important to remember that a budget is only looking at the income and expenses for your business. Items such as asset purchases and loan repayments don’t get included. If you want to get a clear picture of your total business cashflow then you’ll need to prepare a cashflow forecast.

Once you’ve figured out your annual budget, you can divide each line by the number of months you’ve set it for to get average monthly figures. Or, if you know the pattern of income or expenses you can put this in (for example if your income follows a seasonal trend). You can also add in one-off annual expenses if you know them, such as insurance to the month in which you expect to pay. Don’t forget, budgets are GST exclusive so any figures you enter need to be without GST.

Contingency

Business can be unpredictable - equipment may fail, the economy may go through a large downward spiral, your work vehicle may get into an accident or mother nature may have a bad day that ends up flooding your office. It seems somewhat unusual to budget for a problem but if it’s budgeted for, it makes the problem less impactful for your business if it was ever to happen.

Finally – profit and loss and review

With all the information you have collected from the above - it’s time to create a Profit and Loss Statement (P&L) of your budget.

Add up all of your revenue for the month and add up all of your expenses for the month. Then, subtract the expenses from the revenue and hope you get a positive number at the end. If not, it’s not unusual for small businesses to make losses especially when first starting up.

Take a step back and look at this as a full picture. Does it make sense and look like how your business operates? Is there anything that looks glaringly wrong? This is the time to assess if your picture on paper actually reflects reality.

Who are Beany? 

We’re an online accounting firm that is always right here for you, your accounting pain relief. The most advanced technology lets us work way more closely with you than a normal accountant world.

We have a dedicated team of certified accountants and a support team to take care of your business no matter where you are, so you can focus on growing your business. We take out the ‘fluff’, break down the barriers and get things done. Looking out for you is what we are all about. Get started for free today.

Jess Heslop

Jess Heslop

Chief Product Officer

I'm the CPO of Beany where my job is to help craft the best software for our clients and accountants. I'm an ex-big 4 CA and a technology enthusiast, based in Nelson where I live with my husband and two young children.

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