Creating a budget for a business is a complicated process. Even more so if your business is a start-up. There is an umpteen number of factors to consider when it comes to budgeting. Every rupee plays a vital role in a startup budget. To make things more difficult, you may also be trying to achieve maximal growth with small cash flow. This does not leave much scope for financial planning.
Before I went about writing this article, I imagined that budgeting was part of every business process. A survey I came across showed that 61% of small businesses didn’t even have a budget! Fortunately, I’ve laid out a guide to how you can budget for your startup regardless of whether you are using software, spreadsheets, or paper.
Here’s what I’ve got for you today:
- Why is budgeting important for startup success?
- What are the types of startup budget?
- 7 easy steps to create a startup budget
- How to tackle budgeting challenges?
Why is budgeting important for startup success?
You probably know that developing a startup budget does more than just prevent financial mishaps. It helps in making well-planned and informed financial decisions, which is why it is often regarded as the most important step in running a business. As a startup owner, there are a lot more reasons you need to allot time for budgeting. Let me run you through some:
- Provides an idea on when to recruit employees.
- With a regular budget, you can finance to scale by using real-time business data. This avoids early fundraising and over-borrowing.
- A better estimation of your break-even point so you know exactly when to adjust necessary variables.
- Making predictions of cash shortfalls becomes more accurate so you can line up funds accordingly.
- Generate precise financial statements to share with investors or lenders.
What are the types of startup budget?
Now that you know why a budget is so crucial to the success of your business, let’s see what options you can choose from. Although there are many variations to the kinds of budgets you can adopt, there are 2 main kinds:
1. One-Year Budget
This type is used to forecast weekly, monthly, and even daily expenses. A suitable method of doing this is by preparing a rolling budget and P&L. Since your business is highly dynamic (that’s a compliment), managing your risks has to be done in a timely fashion. When you are starting out, try to have a short-interval rolling budget that is updated consistently annually. That being said, strive to have a monthly or quarterly budget to plan for the future.
2. Long-Duration Budget
A budget that spans over 3 or 5 years enables you to visualize your long term financial goals. I know you’re wondering how you can set specific aims when you’re in the initial phase. But, hear me out. A long term budget does not have to have particular assumptions, however, outline the overall objectives against appropriate references. For example, to estimate a 5-year revenue model, you can benchmark it against predictions of the 5-year industry growth trends. Stay updated with expected inflations, percentage rises, etc.
7 Easy Steps to create a startup budget
I took you through the standard practices on how budgeting can benefit your business strategies. You don’t have to estimate your costs right down to the cent or predict the future perfectly to create a useful budget. What is important is that you forecast numbers based on competitor analysis, market research, or vender quotes.
The important thing to remember is to be cautious when it comes to your projections. A golden rule to follow would be to underestimate revenue and overestimate expenses. Don’t reverse the rule, it won’t go well. Let’s go through the full-fledged ways in which you can begin developing your startup budget.
1. Set a target
While you’re reading this, grab a book, computer, any tool that you usually use. A lot of people underrate the importance of collating data and analyzing results when it comes to budgeting. Tools such as Google Sheets, MS Excel, accounting software, are great for integrated financial planning. Take your time to figure out what layout and timeline you’re looking at. Make a habit of entering sample values to test computerized formulas. This will avoid hours of data entry only to realize the calculations don’t work.
Next, set an upfront goal that will help you differentiate between the ‘must-haves’ and the ‘would-be-nice-to-haves.’ Do not forget to factor in an emergency fund within your startup budget. This should include a minimum of 3 months’ expenses at any given time. You’ll thank me later.
2. List income sources
While developing a budget, it is important to know where your cash may flow in from. One effective way to calculate your earnings is by using customer personas to approximate their purchasing frequency. You can also differentiate prospects by region, expected conversions, etc. A good CRM software really helps you do this. Another way to go about this is to estimate your break-even results. Always be mindful of being realistic when calculating potential revenue or funding sources such as loans, savings, or investment income. Have a discussion with your sales and marketing teams to narrow down projects to take up. Always add a lump sum to this predicted amount for new opportunities. Make sure that everything you list down is justifiable and realistic.
3. Categorize costs into revenue buckets
Categorizing costs can be tricky but I have a simple method to make things easier. Divide your costs into Capital and Operational Expenditure. The former includes any large investments such as land areas, equipment, etc. These costs give you returns several times.
Often, you may have to do a knee-deep analysis of current versus future investments. While doing so, ensure that you mention any and all financial information associated with each project phase. This will force your capital spending to align with your long term financial goals.
While we’re at it, let’s take a deeper look into ‘how much of your budget should be payroll?’
Allocating percentages of your gross revenue for payroll varies according to the kind of business you have. For example, the restaurant industry averages around 30 percent labour costs. If you are into retail, labour expenses will tend to be at 10-20 percent. For most service-based industries, payroll falls under the primary cost. This means that up to 50 percent of your revenue will go into payroll without destroying profitability. In general terms, a safe zone for your business is payroll costs that fall between 15-30 percent of your revenue.
At Asanify, we help startups and SMEs budget better especially for their payroll. Get started today for free.
4. Determine variable costs
As the term suggests, these expenses fluctuate with your sales and production. The most common examples of variable costs include:
- Raw Materials
- Advertising expenditure
- Freelance services
- Utilities, etc.
While you can request quotes from contractors and manufacturers for a lot of these costs, remember to consider how time and season may affect these as well. General & Administrative, as well as travel costs, also fall under this category. You can estimate these on past data but as I said, make quantifiable assumptions for everything. Once you have your fixed and variable costs more or less decided upon, do a quick round-up to make your startup budget realistic.
Note: I would love it if your business did well, but when it does, these costs will also go up. So you will need to find creative ways to reduce your startup costs.
5. Accommodate Interest and Taxes
While I hope this does not hold true for you, if you have a debt, you need to pay up interest. On the other hand, having a large cash balance will get you interest income.
You will also need to budget for annual taxes, which may be different across state locations. If you are faced with net operating losses, understand that they may be from previous losses. Ensure that you accommodate for these factors before setting a target.
6. Create estimates for financial statements
This is critical for a startup during your budgeting process. You may be tempted to project only for your P&L along with the capital expenditure. But take a step ahead, approximate for your balance sheet along with P&L for a comprehensive cash flow estimation. When you do this, you will know how much funding you really need. Map out your assets/liabilities so that you never have to face delayed or absence of funding.
7. Integrate with all departments
When I say integration, this is what I mean: Run your entire budget by everyone involved in the team. Sales, HR, R&D, department heads, and top management. As a startup, you want to make sure that your budgeting strategy makes sense in the real world. For easy business growth, give budgeting the importance it demands through intra-organization discussions.
How to tackle startup budgeting challenges?
It’s no surprise that a process like budgeting can be quite daunting. You can face various problems while drawing up a startup budget right from sticking to the budget to a lack of capital. Let’s look at the most common challenges you may face and how to overcome them.
1. Reduced Cash Flow
This is one of the major challenges for most small business owners. It really doesn’t matter how many assets you may have, if you have no cash, your business is done for. To maintain operations, you have to pay business taxes, manage invoices along with recurring expenses such as payroll and rent.
One way to work around this issue is to streamline your payment processes. Set up online portals or accept payments through GooglePay or Paytm. Sending your clients automated payment reminders can ensure they follow your schedule. For clients who are known to pay late, think up ways to incentivize them like small discounts.
Regardless of the option you pick, ensure that you pay off your full balance every month. Incurring interest on your business credit cards is a definite no-go.
2. Deviation from budget
We did a comprehensive check on what goes into developing a startup budget. Now, you must stick to it. Follow the steps mentioned in the previous sections to review your budgets annually. This way, you can compare results versus predictions and know exactly what is happening when. STAY REALISTIC and look at all your income sources to get a picture of what you are working with. Don’t leave anything out, include all your sales, investment revenues and other account receivables. An important tip is to schedule monthly budget reviews so you’re on track. When you know where you stand, you can make smarter financial decisions.
3. Unexpected Expenses
This is the best time to talk about unexpected expenses courtesy of COVID-19. When I said allocate some money for an emergency fund for every monthly or quarterly budget, this is what I was implying. It is always good to look at past records to better understand future spending. Try to figure out how you can incur minimal financial stress to maintain the pace of the budget. Ask yourself questions like ‘How much can I increase my sales in the coming months?’ or ‘Can I reduce marketing expenses?.’ It is clear that at some point, there will be unforeseen expenses, but the better you are equipped, the less you will be affected.
As with every process, budgeting is key if you want to have a successful startup business. We’ve covered the need for a startup to have a stable budget after which we took a brief look at the types of budgets you can opt for. Then we got extensive insights into the steps you should take to develop a startup budget. Finally, we talked about the challenges you may face while creating a budget and how to take control of the situation.
The best part about budgeting for a startup is that you have hundreds of trends you can experiment with to see what works best for you. Focus on the financial practices that suit your business needs to achieve financial balance throughout the year!
Not to be considered as tax, legal, financial or HR advice. Regulations change over time so please consult a lawyer, accountant or Labour Law expert for specific guidance.