How to Create a Budget for Startups

You can’t downplay the importance of a budget for any business, let alone a startup. Budgets help keep finances under control, assist with strategic decision-making and prompt leaders to take action to control spending.

Budgeting is important, but many startups are not equipped to do it well. According to the U.S. Chamber of Commerce, more than 80 percent of businesses fail due to poor financial planning and cash flow problems. One of the best ways to avoid financial problems is to craft a business budget that can serve as the roadmap to your startup’s success. Read on for a comprehensive overview of the importance of budgeting, the key components involved in a good budget, budgeting best practices and more.

Understanding the Importance of a Startup Budget

Why is a budget so important for a startup? Consider it the ultimate tool for setting your finances straight in your early days of operations, but it also allows you and your startup to set clear goals, control spending and even save for future needs. Budgeting helps align money use with your startup’s goals, ensuring it can grow as you envision and respond to any challenges it faces along the way.

Furthermore, budgeting can also help mitigate risk and optimize resources. Budgeting helps startups plan for any uncertainties they may face along the way, allowing for the better utilization of resources.

Finally, a good budget can also serve as a deciding factor for investors and other business partners, or boost the confidence in investors that are already aligned with your startup.

Key Components of a Startup Budget

Before you can get into specific components of a startup budget, you first have to identify the key components. Here’s a look at some of the fundamental elements that help make up a startup budget:

Startup Costs

Startup expenses are the initial expenses that you’ll need to get your startup off and running. Essential startup costs include things like licenses, equipment, legal fees, initial inventory and more.

Fixed Costs

Fixed costs are expenses that are likely always going to be present and must be accounted for on a month-to-month basis. Some examples of fixed costs include rent, employee salaries, insurance and other overhead costs.

Variable Costs

Unlike fixed costs, variable costs differ from month to month, often fluctuating with startup activity. Some examples of variable costs include utilities, raw materials and marketing spend.

One-Time Expenses

Your startup is likely to incur various one-time expenses in its early days and throughout its tenure. As the name implies, one-time expenses are expenses that aren’t fixed or variable, but only occur once. However, they must still be accounted for. Some examples of one-time expenses may include purchasing major equipment, paying for permits or licenses, or hiring a freelancer to design your logo.

Emergency Fund and Contingencies

Lastly, it’s also important to budget for an emergency fund in the event of an unexpected downturn or event that has the potential to harm your startup for some time. These emergency funds can help your business navigate any difficult times and emerge with minimal impact.

Different Budgeting Methods for Startups

There are also several budgeting methods for startups that you can select from. Here’s a look at some of the most popular methods to decide between:

Zero-Based Budgeting

This type of budgeting consists of justifying all expenses over a new period or year beginning from zero. This differs from other budgeting methods which start off with the previous budget and adjust accordingly.

Traditional Budgeting

Traditional budgeting differs from zero-based budgeting in that the next year or period’s budget starts up from where the previous budget leaves off, essentially rolling from year to year. Traditional budgeting does tend to adjust for inflation, revenue changes and any other unexpected expenses.

Rolling Budgets

Rolling budgets are continuous budgets that begin a new period once the current one ends. Rolling budgets differ from traditional budgets in that they’re not created at fixed intervals. Instead, rolling budgets expand over time. Rolling budgets tend to be best for startups that operate in unpredictable markets, as they help improve accuracy and reduce uncertainty.

Flexible Budgeting

Flexible budgets are just what they sound like — they’re budgets that can be easily adjusted to adapt to and reflect changes in your startup’s overall activity. More specifically, flexible budgets allow startups to change what they allocate based on sales volume and revenue. This can better help determine what budgeted numbers can look like at different sales volumes.

Step-by-Step Guide to Creating a Startup Budget

Step 1: Set Clear Business Goals and Objectives

Start by aligning your budget with your startup’s defined goals and objectives. A good goal-setting method to follow is “SMART,” which is an acronym for specific, measurable, achievable, relevant and time-bound. You should be measuring over both the short-term and the long-term.

Step 2: Estimate Startup Costs Accurately

All initial expenses need to be accounted for when you start the budgeting process. This includes one-time fees, like office space setup, technology infrastructure and marketing costs at launch. Make sure you’re shopping around so you can get the best prices on these startup costs.

Step 3: Project Revenue Streams

Projecting revenue streams is easier said than done — especially for a startup. Some tips to realistically forecast income include:

• Doing market research, competitor analysis and identifying the customer personas that will make up your target market.
• Creating multiple scenarios for your revenue streams. It’s often good practice to create an optimistic one, a pessimistic one and a realistic one.

Step 4: Identify Fixed and Variable Expenses

Identifying and accounting for fixed and variable expenses is a big part of budgeting. Ideally, you want to try to keep your fixed cost as low as possible and also do your best to control your variable expenses. Some strategies for doing this include:

• Shopping vendors for best pricing
• Avoid any unnecessary expenses
• Identify areas of cost reduction
• Negotiate for better rates

Step 5: Allocate Budget Based on Priorities

Your startup should have some early priorities — and it’s important to budget based on them. Some good ideas for things to prioritize with your startup are marketing to get the word out about your product and begin generating sales. Additionally, you’ll need to balance between essential operations and growth initiatives.

Step 6: Plan for Taxes and Regulatory Costs

Another major consideration must be taxes and regulatory costs. Startups must pay federal and state income taxes. They may also have to pay franchise taxes and other taxes. For the most accurate tax and regulatory cost estimates, consider working with a financial advisor or accountant for the best results.

Utilizing Technology and Tools for Budgeting

When it comes to budgeting, technology is on your side. Forget the days of doing everything by hand on paper and make sure you’re optimizing your budgeting process by using leading financial management tools and software programs like QuickBooks and Xero. These solutions are designed to make budgeting easier and more streamlined. They also integrate with the cloud and other accounting solutions that your startup may be using. Budgeting templates and other financial modeling tools can also help take your budgeting to new heights.

Aligning Your Budget with Strategic Planning

Budgets do more than just keep your finances on track. They can help keep you on track to meet your financial goals, help with KPIs and business performance metrics, and encourage startup leadership to hold regular meetings to adjust the budget as things ebb and flow.

Common Challenges in Startup Budgeting and How to Overcome Them

Here’s an overview of some of the main challenges involved in startup budgeting:

Underestimating Expenses

Don’t underestimate your expenses. Some ways to avoid this are to conduct a thorough assessment of the market and conduct research to ensure all bases are covered.

Overestimating Revenue

Just as you don’t want to underestimate expenses, you also don’t want to overestimate revenue. To avoid this, make sure that your revenue projections are conservative and even pessimistic to some extent.

Cash Flow Management Issues

The best way to avoid cash flow issues when you budget is to regularly review your cash flow statements. Monitoring financial statements for issues can help you make adjustments more quickly to avoid long-term problems.

Unexpected Market Changes

Having flexibility in budgeting is important. So too is an emergency fund in the event of unexpected changes in the market.

Best Practices for Effective Startup Budgeting

Curious about some best practices for startup budgeting? Here’s a look:

• Involve key team members to promote collaboration between department heads for more accurate budgeting.
• Regularly review and update your budget. It’s best practice to review budgets at least quarterly or perhaps even as frequently as monthly.
• Maintain financial discipline by sticking to your budget and monitoring expenses.
• Educate yourself on financial matters to enhance your financial literacy.

Case Study: Successful Startup Budgeting Example

Startups can achieve financial success with smart planning and accurate, disciplined budgeting. Startups should carefully assess their initial funding and create the budget accordingly. For instance, in the event that their initial funding is $100,000, perhaps 40 percent goes to product development, 25 percent to marketing, 20 percent to operational costs, 10 percent to a contingency fund and the remaining 5 percent to any one-time fees. From here, the startup could execute, regularly revisit the budget over time and head down a path toward financial success.

How Budgeting Helps in Securing Funding

Budgeting does more than just help keep your finances in order and set a strategic path forward for your startup, it can also help secure funding from investors and lenders. Investors aren’t investing for fun — they’re doing it to help improve their personal wealth. That said, they want to see when they can expect a return and how significant this return has the potential to be. A good budget can help with this.

Scaling Your Budget as Your Startup Grows

If a startup is going to be successful, it’s going to be growing over time — and as startups grow, their budgets will need to be adjusted. A great opportunity to scale budgets is when you sit to review your annual budget, regardless of how frequently that is. This is when you can make changes to reflect a growing operation, changes that may include hiring, entering new markets and accounting for increased revenue. Budgets should be flexible enough to change when there are adjustments to the startup and its financial goals.

Crafting a Budget as a Roadmap to Startup Success

A budget is one of the most important things your startup can establish to get it started on the right foot and avoid some of the financial pitfalls that can come with poor financial planning. A budget also helps provide a roadmap to sustainable growth past your break even point and can help attract investors. Make sure you prioritize your startup’s budget and seek professional help if you need it.

Take Charge of Your Startup’s Financial Future

For help with creating a budget for your startup, contact Graphite Financial today. As experts in all things accounting and with a specialty in helping startups excel and grow, our experts provide tailored solutions to help facilitate growth. Contact Graphite today for more information on our financial services and to schedule a free consultation.

FAQs

What is the first step in creating a startup budget?

You first have to identify the key components of your budget. These include fixed expenses, variable expenses, one-time expenses, startup costs, and emergency funds and contingencies.

How often should a startup review its budget?

It’s best practice to review budgets at least quarterly or perhaps even as frequently as monthly.

Why is cash flow management important in a startup budget?

Operating cash flow is important because it’s essentially the lifeblood of being able to pay your startup’s operating expenses. It can also help show whether your startup has the money to grow.

What tools can assist in creating and maintaining a startup budget?

Make sure you’re optimizing your budgeting process by using leading software programs like QuickBooks and Xero. These solutions are designed to make budgeting easier and more streamlined, and they integrate with the cloud and other accounting solutions.

How can a startup budget help in attracting investors?

Investors want to see when they can expect a return and how significant this return has the potential to be. A good budget can help with this as well as help prove that a startup is serious about financial discipline.

What should I do if my actual expenses exceed my budgeted amounts?

If this becomes the case, it’s time to reassess your budget and adjust it accordingly so that you correct course. Additionally, this may also be a situation where your emergency fund or contingency funds come into play if the cause of the higher expenses was unexpected or temporary.

How do I account for unexpected expenses in my startup budget?

It’s important to budget beyond ongoing costs for an emergency fund in the event of an unexpected downturn, expense or event.

What is zero-based budgeting, and is it suitable for startups?

Zero-based budgeting consists of justifying all expenses over a new period or year beginning from zero. It can be suitable for startups that may be starting fresh.