Creating a budget for a business is an arduous process at the best of times. But for business owners of startups, it’s even more challenging.
Startups by their very nature are not flush with cash. For business owners, that means every business decision made must be made in accordance with tight expenditure lines, which can be difficult if the business is growing at a substantial rate.
When business owners consider how to create a startup budget however, their process needn’t be mathematically complex. In fact research has shown that 51.2% of all startups begin their business with a budget of less than £5,000.
So when it comes to creating a startup budget, here are the key things to keep in mind and the exact steps to take.
Why is budgeting important?
General research has shown that around 8.9% of all startups do not have an initial budget. This is concerning for a business of any size, and may be a contributing factor as to why startups have a substantially high failure rate.
Budgeting is important for businesses of all sizes, but for startups it’s perhaps more crucial to ensure the business has a steady footing and can continue to thrive. A startup budget can serve as a useful tool to determine:
- When startups can begin to recruit employees
- When startups can begin scaling
- Accurate estimations of break even points so that necessary variables can be adjusted
- Predictions of cash shortfalls or profitable months
- Precise financial statements to prepare for potential lenders, partners or investors
The 2 types of start up budgets
Whilst there are three main types of budgets (budget, surplus budget and deficit budget), for startups these same rules don’t tend to apply because of the lack of financial information or expenditure available.
Instead startup budgets can usually fall into one of two categories. These are:
- A One Year Budget
These budgets tend to be short term and are used to forecast monthly, weekly and even daily expenses. Given the high failure rate for the first year of a businesses life, short-term budgets are wise and enable business owners to take each day, week, or month as it comes.
To create a one year budget it’s best to prepare both a rolling budget and a rolling profit and loss statement. Having a short-interval rolling budget that is constantly updated will help a startup to manage its risk by giving it a more detailed overview of its expenses, and will allow it to adjust variables at short notice (say within a day).
Even with a one year budget, startups should still aim to have either a quarterly or annual budget to help transition the business into planning for the future.
- A Long Duration Budget
Long duration budgets are the opposite of short term budgets, as these are made with a three to five year duration period in mind. Whilst this may seem ambitious for a startup straight out of the gate, a long term budget helps a business to set overall goals and objectives which it can then adjust its financial information to help achieve.
For example, if a startup wants to own its own premises within three years, it could begin saving a percentage of its profits, or creating a suitable environment for an investor or partner to come on board by displaying balanced books across its first two to three years trading.
Long duration budgets can still assess shorter term goals, such as at monthly or weekly intervals, but they tend to serve as blueprints for startups with serious ambitions in mind and who will be notably strict in their expenditure.
What should be included in start up costs?
Once a startup has decided which startup budget template it will be following – whether long or short term – the first step should be to determine what its initial outgoings will be.
Startup costs don’t tend to vary dramatically from the initial setup costs of any new business, and will most likely include things such as:
- Equipment, e.g computers, machinery
- Incorporation fees
- Office space, if necessary. If not office space could be interspersed with the cost of business liability insurance, especially if the business will be initially run out of a home premises
- Inventory, if the business will be manufacturing goods
- Marketing costs, including advertising and website creation
- Furniture and supplies, if necessary
- Utilities: If the business is being run out of a home premises, utilities still apply although home workers can claim expenses which you can read more about here.
- Payroll, if the startup will need to take on an employee, contractor or freelancer
- Professional consultants, or accountants
- Taxes and VAT, depending on whether the pros and cons of registering for VAT align with the startup
- Travel Costs, if the business is out in the field or will be importing or exporting
- Shipping Costs
Depending on the type of startup and its industry will depend on which of the above apply, but everything should be considered, from utilities to location to potential manufacturing, packaging and invoicing costs.
If you’re wanting to begin your startup from your home premises, don’t do so without reading our guide as to how to start a business from home.
What are the 6 steps in creating a budget?
Many startups fall into the misconception that their costs must be predicted accurately to have any use, which is usually what dissuades business owners from initially creating one. The good news is that they don’t. Instead costs and expenses should be forecasted based on accurate research, for example through competitor analysis, market research or supplier quotes.
As we go through the following steps, it may be worth bearing in mind one crucial piece of recommended advice for any startup: Underestimate revenue and overestimate expenses will always ensure it errs on the right side of caution.
- Set goals
Startups may not think it’s wise to run before they can jump, but actually setting goals can help to keep income and expenses on the right track. The process doesn’t need to be a complicated set of equations either: Collating data and analysing the information in software like Google Sheets, Microsoft Excel or other accounting software can be a useful way to get accurate financial projections.
Ideally business owners should have some form of timeline in mind, i.e to achieve X by month 6 and be on track for Y by month 12, as this will help shape their overall incomings and outgoings.
Goals can also extend to things such as necessities, nice-to-haves, luxuries and of course an emergency fund with enough to fall back on to feel safe. It’s recommended that emergency funds contain at least three months of expenses at any one given time, so this is definitely something to factor into financial goal planning.
- Identify sources of income
One of the most important aspects of any budget is its income. Income projections can be more difficult to ascertain for startups because they may be unsure of their consumer demographic, or may not have enough market knowledge to go on.
To counteract this, competitor analysis can help, as can the detailed planning and prediction of customer personas. Simple research tricks that can help businesses to approximate the costs of each consumer and their purchasing frequencies.
Other ways to determine this information include estimating break-even results. Startups must however be mindful of remaining realistic when calculating break-even costs, especially if they are relying on directors loans or investment incomes. Staying realistic, or as accurate as possible in the predictions, and underestimating income can help to keep income projections on track.
- Divide costs by expenditure
Dividing costs into capital and operational expenditure is one way to categorise costs and therefore safety proof any analysis between current and future investments.
Large investments, like land or office premises can fall into the capital expenditure, whilst other costs, such as payroll, can fall into operational. Splitting different purchases into different categories ensures that each project phase is kept accurate and transparent, with no room for confusion or overspending, helping to align capital with longer term financial goals.
- Determine and plan for variables
Variables are expenses that fluctuate. Examples of common variables include:
- Raw Materials
- Marketing costs
- Shipping costs
- Freelance or Contractor invoices
- Utility costs
Whilst fairly accurate quotes can be ascertained from contractors, insurance and utility providers, it’s still worth remembering that these variables fluctuate because they are affected by time, demand and season. For example a home office in the winter will use more central heating to keep it warm. Likewise shipping costs will increase in peak seasons, like Christmas.
Variables can be estimated using past data, but it’s best to make as accurate an assumption as possible and always plan for the worst case scenario.
- Include interest and taxes
Very often startups may borrow money to get off of the ground, especially if they are in immediate need of premises or equipment. In these cases, the budget must accommodate for any interest accrued as an expense. On the other hand if the startup has a large cash balance behind it, that may also generate income in the startups favour so that must also be accounted for as it could positively impact income.
The cost of taxes also needs to be considered. If your business is profitable, you need to know how much to be setting aside for corporation tax as well as when it needs to be paid.
- Estimate financial statements
It might be tempting with a startup budget to only project profit and loss alongside capital expenditure, but this could be a mistake. Instead it’s worth approximating the balance sheet alongside the profit and loss sheet to gain a more comprehensive understanding of working capital needs to help understand your future cash flow estimations.
That information will also help business owners to understand how much potential financial backing they need from lenders or investors.
Finally, once you have an estimated financial statement and what looks to be a budget plan, pass it around co-directors, founders, friends, or even initial employees to get feedback as to whether the budget is justifiable, realistic, and coherent.
Ready to get started?
Creating a budget is a vital step for any new business, but for startups it is an imperative task to undergo. Budgets can help track the progress of the business and prepare business owners for fluctuations in expenses and income, as well as stabilise the business goals.
At iFinance Department we help small businesses grow by offering them financial services which include budget management. Our services include access to Xero accounting software, bookkeeping and accounting services, and even tax and payroll management. We also use powerful tools for P&L and cash flow forecasting as well as KPIs and setting alerts to monitor financial health. Click here to find out more about how we can help your startup, or contact us for a quick chat.