How to create a small business budget and forecast with confidence

Being in control of your finances and cash flow is a vital part of keeping your business successful and profitable. This starts with creating, tracking and measuring your performance against a defined budget.

In this article, we take a look at what a typical ​​small business budget should include, how you stay on track with this budget and how forecasting can support your financial health.

Why budgeting matters

A well made small business budget estimates your future revenue and expenses over a specific period. It helps you track your cash flow against this pre-agreed budget, control your spending and allocate resources effectively.

The budget also helps you set financial goals, giving you a financial roadmap for making important operational and strategic decisions. 

Your budget gives you:

• Detailed financial clarity of your current and future financial path
• Data-driven decision-making, based on genuine numbers 
• Relevant information to drive your operational and strategic planning
• Informed risk management, based on how you’re tracking against the budget

With a budget in place for the business, you can set realistic business goals and track your progress against these goals, while keeping spending under control.

How to create a small business budget, step by step

Creating a budget for your business does require a basic understanding of accounting and financial management. But with this step-by-step guide, we’ll walk you through the process of finding the relevant numbers to help you build your budget.

To create your budget:

1. Identify your income sources and estimate the company’s revenue: 

Begin by listing all the different ways your business generates money. These revenue streams could be created through sales of your products and/or services, recurring subscriptions your customers pay, or passive income streams like intellectual property. 

For each source, estimate your expected revenue over the budget period – this will be monthly, quarterly or annually, in most cases. Use historical accounting data, current trends and sales forecasts to make realistic projections of these revenue numbers.

2. Categorise your fixed and variable expenses: 

Next, meticulously list all your business expenditure – these are the costs you incur while running the business. There are two key types of expenditure to record: your fixed expenses and your variable expenses. 

Fixed expenses are the costs that will generally stay the same regardless of your sales volume. These costs include things like rent, insurance premiums, software subscriptions and fixed salaries for your workforce.

Variable expenses are the costs that fluctuate with your business activity. These can include items like raw materials, shipping costs, sales commissions, hourly wages related to production, or marketing spend that’s tied to your sales activity.

3. Set your spending limits and look for areas to cut costs: 

With your income and expenses mapped out, it’s time to set realistic spending limits for each expense category you’ve identified – including both fixed and variable costs. 

Compare these limits against your estimated revenue for the period. You’ll be able to see if the proposed expenditure will fall above or below your projected revenue number. If expenditure is less than your total revenue, you’ll make a profit. If costs exceed your revenue, you’ll be operating at a loss. 

This step is crucial for finding the areas where your costs can be reduced without compromising quality or essential operations. Look for unnecessary spending or potential efficiencies and do everything you can to boost profitability.

4. Include contingency funds for any unplanned expenses: 

Finally, allocate a portion of your budget as a contingency or emergency fund. This vital buffer – typically 10-20% of your total expenses – helps absorb any unexpected costs that aren’t included in your existing budget.

External conditions and unplanned costs can appear without warning, so this contingency in your budget is essential. Equipment can break down, markets can dip and weather conditions can damage your property. With your contingency funds in place, you can cover the costs without derailing your entire financial plan.

What to include in your business forecast

Your small business budget isn’t a static measurement of your profitability. The numbers in your budget allow you to run financial projections, allowing you to forecast how profitable the business may be in future periods. 

This is essential for understanding where costs may be too high in the future, and taking steps to improve your overall future profit margins.

Here’s a rundown of what to include in your business forecast:

• Projected income (revenue): This is the starting point of your budget. Forecast all money that you anticipate coming into the business over the budget period to get the top line figure, from which all expenses will be subtracted.
• Projected expenses: List all expected expenses and subtract the total from your projected total income. This expenses total will include both your cost of goods sold (direct costs) and your operating expenses (overheads like rent, salaries and marketing etc.). You’ll also set realistic limits for each category.
• Projected profit: Profit is your revenue minus your total expenses. After subtracting all projected expenses from your projected income, the remaining figure is your projected profit, whether it’s the gross, operating or net profit. This indicates whether the business will be profitable and by how much, helping you make informed strategic decisions and make amendments to boost profits.
• Projected cash flow: While profit shows your overall financial gain, projected cash flow focuses on the timing and movement of actual money. Your budget includes anticipated cash inflows (when revenue is received) and cash outflows (when expenses are paid). This is crucial for managing your daily liquidity, so you have enough cash on hand to meet your obligations – even if your business is profitable on paper. It helps prevent cash shortages.

Taking into account the external conditions

You can create a highly accurate forecast using your historical accounting and sales data. But it’s impossible to know exactly what lies ahead in the future.

When creating your projections, try to consider changing market trends, the appearance of new competitors and the impact of seasonal factors on your sales pipeline and overall sales revenue. 

You can base this on past performance data from previous periods, and existing benchmarks within your niche sector or industry.

The key thing is to continue monitoring external conditions throughout the period, so you can see where the threats are and can adjust your strategy accordingly.

Budgeting vs forecasting: key differences and when to use each

When working on the financial management of the business, it’s important to know the difference between a small business budget and a forecast. 

Budgets are a tactical tool that you use when planning your spending, and reviewing your spending goals against real-time revenue and cash flow.  

Forecasts are a strategic tool that projects your revenue, expenditure and cash flow forwards in time, helping you make informed strategic business decisions.

When used in tandem, budgets and forecasts give you a comprehensive overview of your financial management. By tracking, measuring and analysing these two different financial metrics you can be as proactive as possible about remaining profitable.

What’s the difference between a budget and a forecast?

A budget is a financial plan that outlines what you expect to happen over the coming period. It sets out specific pre-agreed spending limits and revenue targets for this fixed period, whether it’s the next month, quarter or year.

A forecast is a dynamic prediction of what’s likely to happen, based on your existing, historical data and information on your market. It’s used to project your financial performance forward into the future, and can be used to foresee potential profit challenges, cash flow gaps, or opportunities to boost revenue.

How to budget with inconsistent income or seasonal sales

In many industries, especially in those with seasonal peaks in sales, your income won’t be consistent across the entire financial year. So, if your revenue differs across the period, what can you do to create accurate budgets and forecasts?

Here are some practical approaches to try:

• Understand your revenue cycles: Look through your historical data to find the seasonal patterns and revenue triggers. By factoring these patterns into your forecasts, you’ll make them more accurate and indicative of ongoing revenue and cost levels over the course of the year.
• Use scenario-based budgeting: Create multiple budgets that cover best, realistic and worst-case scenarios. By factoring ‘what-if scenarios’ into your forecasts, you prepare the business for multiple outcomes and can tailor your budgeting to the upcoming state of the market.
• Prioritise your cash flow and reserves: Consistently forecast your cash flow position, so you’re on the ball and ready to anticipate any cash needs. By building up substantial cash reserves during high-revenue periods, you create  a crucial buffer for the leaner months. This stops you being adversely affected by low revenues and poor cash flow during quieter periods. 
• Be flexible with managing expenses: Get proactive about controlling your variable costs during any potential downturns. Review all your operating expenses on a regular basis and check whether the costs are still justified when balanced against your current, lower revenue levels. If there’s room to reduce these expenses then look around for cheaper vendors, discounts for buying in bulk, or options for suppliers agreeing to trade credit.  
• Use software tools and partner with an accountant: Cloud accounting software has many ways to track your profit and loss and cash flow in real time. By working closely with your accountant and using the latest cloud reporting and forecasting tools, you’ll have the best possible current view of your cash position. You’ll also get timely advice on how to react to seasonal peaks and troughs in your sales revenue. 

Common budgeting mistakes to avoid

Getting your budget on point does require a basic understanding of business accounting. When you first start out as a new entrepreneur, being on top of all the technical elements of financial reporting can be a challenge. 

Here are some of the more common traps to avoid when running a small business budget for the first time:

Make a conscious effort not to:

• Overestimate your revenue: be realistic with the sales revenue you can bring in over the period of the budget in question.
• Underestimate your expenses: Don’t misjudge the true cost of your variable and fixed expenses. This figure must be as accurate as possible. 
• Ignore cash flow or irregular costs: Keep a close eye on your cash flow position and see how it’s tracking alongside any unexpected costs.
• Forget to review and update your budgets: Budgets require frequent reviews, so you can spot where revisions and updates are needed. 

How often should I update my small business budget?

Review and update your budget at least quarterly, but preferably on a monthly basis. These regular reviews allow you to measure how your budget estimates are tracking against real-time revenue and expenditure. 

An annual budget review is essential, so you can set a clear and updated budget for the forthcoming year. 

Using your budget to support a business loan application

When you apply for a business loan, the lender’s major concern is that you’re a viable, stable and profitable business. In other words, they want to know that you’re a low-risk borrower who can make the loan repayments.

Having a clear and well-thought-out budget is extremely helpful. Your budget and forecast give the prospective lender an overview of your revenue, expenses and potential profits. This is vital information when assessing whether to grant the loan.

Having a detailed budget and forecast also shows you’re responsible with your financial management – a major consideration for the prospective lender. 

Many lenders, including specialist online business lenders like iwoca, will use your budget to evaluate their funding decisions. So, the more budgetary information you can provide, the better your case will be for getting the loan approved. 

Can a business loan help if my forecast shows a cash gap?

Yes, a short-term business loan, like an iwoca Flexi-Loan, is a highly effective way to bridge any cash shortfalls that show up in your forecasts. You can use debt financing to fill the cash gap and repay the borrowed money over an agreed timeframe – with this additional cost factored into your revised budget. 

Tools and templates to simplify your small business budgeting

Cloud accounting software gives you straightforward and easy-to-use tools for generating a detailed budget for your company. 

There are step-by-step guides to building a budget in Xero, QuickBooks, Sage and many of the major accounting platforms.

If you’re not using cloud accounting software, you can always use a basic spreadsheet to create your budget. There are templates for Excel budget tools and Google Sheets tools that help you create basic budgets for your business.

iwoca: helping you bridge your cash flow gaps

Despite your best budgeting intentions, market conditions may not always go exactly to plan. That could mean an unexpected bill, or a fast-selling product that you need to double down on. When you need extra capital, quickly, an iwoca Flexi-Loan provides speed, flexibility and control.

With a Flexi-Loan, you can:

• Borrow from £1,000 to £1 million to manage your cash flow 
• Repay the loan in 1 day to 60 months
• Get the money in a matter of hours

Apply for an iwoca Flexi Loan

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