Although you might not know it, you prepare a budget each time you estimate how much cash you will have left at the end of the month after paying your bills.   A budget is a forecast of all cash sources and cash expenditures. It is organized in the same format as a financial statement, and most commonly covers a 12-month period. At the end of the year, the anticipated income and expenses developed in the budget are compared to the actual performance of the business as recorded in the financial statement.

A budget can greatly enhance your chances of success by helping you estimate future needs and plan profits, spending and overall cash flow. A budget allows you to perceive problems before they occur and alter your plans to prevent those problems.

In business, budgets help you determine how much money you have and how you will use it, and help you decide whether you have enough money to achieve your financial goals.

As part of a business plan, a budget can help convince a loan officer that you know your business and have anticipated its needs.   A budget will indicate

  • The cash required for necessary labor and / or materials.  

  • Total start-up costs.

  • Day-to-day maintenance costs.

  • Revenues needed to support business operations.  

  • Expected profit.   If your budget indicates that you need more revenue than you can earn, adjust your plans by  

  • Reducing expenditures (e.g., hiring fewer employees, purchasing less expensive furniture, eliminating a telephone line).  

  • Expanding sales (e.g., selling additional products or services, conducting an aggressive marketing campaign).

  • Lowering profit expectations (usually the least desirable option).  

Every business should create a budget before investing money in new equipment or other assets and before signing leases. To ensure your goals can be reached, first put all the numbers down on paper so you can adjust and rework them as many times as necessary. Mistakes are far less costly when made on paper than with actual dollars. .

Basic Budgeting Concepts

The three main elements of a budget are

  • Sales revenue

  • Total costs

  • Profit

Sales Revenue

Sales are the cornerstone of a budget. It is crucial to estimate anticipated sales as accurately as possible. Base estimates on actual past sales figures. Once you target sales, you can calculate the related expenses necessary to achieve your goals.

Total Costs

Total costs include fixed and variable costs. Estimating costs is complicated because you must identify which costs will change and by how much and which costs will remain unchanged. You also must consider inflation and rising prices when applicable.

Variable Costs

Variable costs are those that vary directly with sales. One example is the purchase cost of inventory. The more inventory you sell, the higher your purchasing costs; the less you sell, the lower your purchasing costs. Similarly, freight and special packaging costs will vary directly with sales; these costs will not be incurred without a sale.

For example, a store owner pays $350,000 for supplies and sells them for $500,000. To calculate the cost of inventory purchases as a percentage of sales, the owner divides the amount paid by the amount received in sales (350,000 500,000 = 70 percent). This means 70 percent of sales will go to pay for the cost of inventory. If the store owner estimates $600,000 in sales for the next year, he or she should budget 70 percent of $600,000, or $420,000, for inventory purchases.

Fixed Costs

Fixed costs are those that do not change, regardless of sales volume. Rent is considered a fixed cost because it is totally independent of sales activity and, for the duration of the lease, will not change. For example, a five-year lease with an annual rent of $24,000 must be paid even if there are no sales. It doesn't matter whether sales are high or low; the rent is still $24,000.

Semivariable Costs

Semivariable costs, such as salaries, wages and telephone expenses, have both variable and fixed components. For budgeting purposes, you may need to break semivariable costs into these two components. The fixed element represents the minimum cost of supplying a good or service. The variable element is that portion of the cost influenced by changes in activity. Examples of semivariable costs are the rental of delivery trucks and photocopying machines for a fixed cost per month plus a variable cost based on the volume of usage.

Inflation and Other Adjustments

A budget will be as good as the numbers used to make it.

Therefore, it is important that your estimates and calculations be as accurate as possible.

Profit should be large enough to make a return on cash investment and a return on your work. Your investment is the money you put into the firm when you started it and the profit of prior years that you have left in the firm (retained earnings). If you can receive 10 percent interest on $25,000 by investing outside of your business, then you should expect a similar return when investing $25,000 in equipment and other assets within the business. When preparing your budget, add the expected return on investment to your targeted profits. Check with your trade association, accountant or banker to make sure that the rate of return on your investment is what it should be.

In targeting profits, you want to be sure you are receiving a fair return on your labor; your weekly paycheck should reflect what you could be earning elsewhere as an employee.


Excel 2007: Creating Business Budgets

Basic Budget Equation

Sales = total cost + profit

This equation shows that every sales dollar you receive is made up partly of a recovery of your costs and partly of profit.

Another way to express the basic budgeting equation is Sales - total cost = profit

This equation shows that after reimbursing yourself for the cost of producing the product or service, the remaining part of the sales dollar is profit. For example, if you expect $1,000 in sales income and you know that it costs $750 to produce, market and sell your product or service, your profit will be $250.

Realistic Estimates

In calculating an operating budget, you will often make estimates based on past sales and cost figures. You will need to adjust these figures to reflect price increases, inflation and other changing factors.

For example, for the past three years, a store owner spent an average of $3,500 for advertising costs. For the coming year, the owner expects a price increase of 3 percent (.03). To calculate next year's advertising costs, the owner multiplies the average annual advertising costs by the percentage price increase (3,500 = 105) and adds that amount to the original, annual cost, (3,500 + 105 = 3,605). A shortcut method is to multiply the original advertising cost by one plus the rate of increase (3,500 1.03 = 3,605).

If your business is a new venture and has no past financial records, rely on your own experience and knowledge of the industry to estimate demand for and costs of your product. You may need to enlist the assistance of a professional accountant or business consultant. If your budget is to be helpful, you must use realistic estimates.

The Budgeting Process

Before you can create a budget, you must answer three questions:

  • How much net profit do you want the business to generate during the calendar year?

  • How much will it cost to produce that profit?

  • How much sales revenue is necessary to support both profit and costs?

To answer the above questions, consider expected sales and all costs, either direct or indirect, associated with the product or service. To make the safest estimates when budgeting, most companies prefer to overestimate expenses; conversely, they prefer to underestimate sales revenue.

Constructing a Budget

Start with either a forecast of sales or a forecast of profits.

For practical purposes, most small businesses start with a forecast of profits. In other words, decide what profit you want to make and then list the expenses you will incur to make that profit. To create a budget

  • Target desired profit.

  • Determine operating expenses.

  • Calculate gross profit margin.

  • Estimate sales revenues. Adjust figures.

Budgeting requires you to consider your basic objectives, policies, plans and resources.

  • It requires you and your key employees to undertake a coordinated, comprehensive and informed effort to achieve common objectives.

  • It helps you to ensure that proper controls and evaluation procedures are established throughout your company.

  • It encourages and motivates everyone concerned to put forth a reasonable effort.

  • It provides a plan so that all of you know where you are going, as well as why, how, when and with whom.

In short, the budgeting process is a valuable tool in planning, income and expense.

You can prepare a budget to cover practically any time period. Usually, a one-year budget is developed. In most cases, it is projected on a quarterly basis, with each quarter detailed in months (sometimes weeks). It is also possible to prepare budgets for two, three and five years. Anything beyond five years generally is impractical.

The following simplified examples give you an idea of the various interrelations developed in the budgeting process. (These figures are relative to one given set of values. Of course, different volumes of business would determine different costs and thus affect the realizable profits.) Using these concepts as a framework, you and your staff can set up your own comprehensive profit-planning budget.

A cash flow budget is a projection of your business's cash inflows and outflows over a certain period of time. A typical cash flow budget predicts the anticipated cash receipts and disbursements of a business on a month-to-month basis. However, a cash flow budget could predict the cash inflows and outflows on a weekly or daily basis. Because of the uncertainty involved in the cash flow budget, trying to project too far into the future may prove to be less than worthwhile. At the same time, a cash flow budget that doesn't look far enough into the future will not predict future events early enough for you to take corrective action in your cash flow.

A six-month cash flow budget minimizes the amount of uncertainty involved in the budget. It also predicts future events early enough for you to take corrective action. However, if you're applying for a loan, you may need to create a cash flow budget that extends for several years into the future, as part of the application process.

The primary purpose of using a cash flow budget is to predict your business's ability to take in more cash than it pays out. This will give you some indication of your business's ability to create the resources necessary for expansion, or its ability to support you, the business owner. The cash flow budget can also predict your business's cash flow gaps — periods when cash outflows exceed cash inflows when combined with your cash reserves. You can take cash flow management steps to ensure that the gaps are closed, or at least narrowed, when they are predicted early. These steps might include lowering your investment in accounts receivable or inventory, or looking to outside sources of cash, such as a short-term loan, to fill the cash flow gaps.

Preparing a cash flow budget involves four steps:

  • preparing a sales forecast

  • projecting your anticipated cash inflows

  • projecting your anticipated cash outflows

  • putting the projections together to come up with your cash flow bottom line.

Projecting Cash Inflows

Projecting cash receipts for your cash flow budget involves recognizing the cash inflows from a sales forecast. If your business only accepts cash sales, then your projected cash receipts will equal the amount of sales predicted in the sales forecast.

Projecting cash receipts is a little more involved if your business extends credit to its customers and deals with accounts receivable. If this is the case, you must take into account the collection of accounts receivable and the timing effect that collection has on the projection of your cash receipts. Applying your accounts receivable collection pattern from the past to your sales forecast is the best way to predict your cash receipts from the collection of accounts receivable.

Projecting Cash Outflows

Projecting your cash outflows for your cash flow budget involves projecting your expenses and other cash outflows over a certain period of time. Projecting your expenses for the next month or six months may seem like a difficult task. You may even feel like you're guessing when projecting some of your business's expenses. After all, there are a number of different variables that ultimately determine the amount of each expense.

An accounts payable aging schedule may help you determine your cash outflows for certain expenses in the near future — 30 to 60 days. An accounts payable aging schedule lists all of the amounts you owe to your suppliers. This will give you a good estimate of the cash outflows necessary to pay your accounts payable. Another tip for projecting your cash outflows is to classify each of your business' expenses. The cash outflows for every business can be classified into one of four possible categories of cash outflows:

  • costs of goods sold

  • operating expenses

  • major purchases

  • debt payments

Projecting Outflow for Debt Payments

This category of cash outflows includes all regularly scheduled and unscheduled loan payments.

Cash outflows in the debt payment category are probably the easiest to predict when preparing your cash flow budget. Debt payments, such as a mortgage payment, are usually made at the same time each month, and for the same amount each month. Cash flow budgeting for this category is just a matter of including the same amount for each month in your cash flow budget

Projecting Outflow for Cost of Goods

A cash outflow falls under this category if it is for the purchase of inventory items resold to your customers, or for inventory items used to manufacture an end product. This category includes all your cash outflows for expenses included in your cost of goods sold. If your business is a retail business, your largest cash outflow is probably for the purchase of resale items. If your business involves manufacturing goods, a large portion of your cash outflow may fall into this category if you purchase raw materials and other goods used in manufacturing your final product. If you have a service-related business, it's likely that only a small amount of your cash outflow will fall under this category.

Predicting the cash outflows in the cost of goods sold category can be a little tricky, but not impossible. The best way to complete your cash flow budget with your costs of goods sold is to base the amount of your cost of goods sold on your sales forecast. This prediction is based on a simple relationship — in order to achieve a certain level of sales, your business will have to incur a corresponding amount of cost of goods sold to support it. Using sales information and the cost of goods sold information from prior years should allow you to determine this relationship, and express your cost of goods sold as a percentage of your sales. Industry information may be available for your type of business if you don't have prior sales and cost of goods sold information to work with. This information may serve as a starting point for predicting your costs of goods sold.

Projecting Outflows for Expenses

A cash outflow falls under this category if it is cash paid out for operating expenses. Operating expenses are all the expenses you incur while operating your business. Examples of operating expenses include payroll and payroll taxes, utilities, rent, insurance, and repairs and maintenance. A good rule of thumb is that if the cash outflow doesn't fit under any of the other three categories (debt payments, cost of goods sold, or major purchases), it's probably an operating expense.

Predicting cash outflows for operating expenses when preparing a cash flow budget can be quite easy in some instances, and difficult in others. Rent, for example, is one operating expense that should be fairly easy to predict since it is usually the same amount month after month. Other operating expenses, such as payroll and utilities, may not be so easy to predict.

As when you predict cash outflows for the cost of goods sold, the best way to predict operating expense outflows is to base them on your sales forecast. This prediction is based on a simple relationship — in order to achieve a certain level of sales, your business will have to incur a given amount of operating expenses. Using sales information and operating expense information from prior years should allow you to determine this relationship and express your operating expenses as a certain percentage of your sales. Industry information may be available for your type of business if you don't have prior sales and operating expense information to work with. This information may serve as a starting point for predicting your operating expense cash outflows

Projecting Outflows for Major Purchases

When preparing a cash flow budget, you must predict the cash outflows for major purchases, such as property or equipment, vehicles, computers, or other office equipment. Major purchases are usually the result of a business expansion, a business improvement, or a business replacement expenditure. Cash outflows in this category are generally large and don't occur that often during your business year.

As the owner of your business, you are probably the best predictor of the cash outflows in this category. If you look for your business to expand during the budget period, then you probably have a pretty good feel for the additional equipment, office space, or office equipment needed to undertake the expansion. You also probably know when it's time to replace the old delivery van with a newer model, or when it's time to get rid of the old 386 PC and replace it with a new Pentium PC.

The cash flow budget is an excellent tool to help you determine when or when not to make major purchases. If your cash flow budget shows that additional funds may be available at a certain point, this should provide you with the opportunity to make advance purchase decisions. Planning ahead may allow you to take advantage of lower prices, discounts, or better financing options. Likewise, if your cash flow budget shows that your cash supply might be a little tight, it's probably not a good idea to make a major purchase, or take on an additional monthly loan payment.

Putting the Projections Together

The final step in preparing a cash flow budget is putting together your projected cash inflows and outflows to come up with your cash flow bottom line. In its basic form, the competed cash flow budget combines the following information on a month-by-month basis:

Beginning Cash Balance

+ Projected Cash Inflows

- Projected Cash Outflows

= Your Cash Flow Bottom Line (the ending cash balance)

You'll definitely want to include a little more detail in your cash flow budget than what is listed above. However, the basic form of the cash flow budget will always remain the same.

The ending cash balance for the first month becomes the second month's beginning cash balance. The second month's cash flow bottom line is determined by combining the beginning cash balance with the second month's anticipated cash inflows and cash outflows. The ending cash balance for the second month then becomes the third month's beginning cash balance. This process continues until the last month of the cash flow budget is completed.

A positive cash flow bottom line indicates your business has a cash surplus at the end of the month. A negative cash flow bottom line indicates that your business has run into a cash flow gap — a period where cash outflows exceed cash inflows when combined with your beginning cash balance. If a cash flow gap is predicted early enough, you can take cash flow management steps to ensure that your cash flow gap is closed, or at least narrowed. These steps might include:

  • increasing your anticipated cash inflows from accounts receivable collections

  • decreasing your anticipated cash outflows by cutting back on inventory purchases or cutting certain operating expenses

  • postponing a major purchase

  • looking to outside sources of cash, such as a short-term loan to fill the cash flow gap

In other situations, filling the cash flow gap may require you to look to external financing sources.


Projected Cash Inflows

The following are examples of some of the detailed cash inflows that you may want to include when projecting your cash inflows for your cash flow budget.

Projected Cash Inflows (Receipts):

  • sales and receipts

  • collections on accounts receivable

  • loan proceeds

  • other cash inflows

Projected Cash Outflows

The following are examples of some of the detailed cash outflows that you may want to include when projecting your cash outflows for your cash flow budget.

Anticipated Cash Outflows

  • Cost of goods sold

  • inventory purchases

  • shipping and handling

  • manufacturing costs

  • Operating expenses

  • payroll

  • payroll taxes

  • advertising

  • subscriptions and dues

  • professional fees

  • office and postage

  • rent

  • utilities

  • insurance

  • taxes and licenses

  • supplies

  • repairs and maintenance

  • credit card fees

  • bank service charges

  • other operating expenses

  • One-time purchases

  • new property or equipment

  • Debt payments

  • interest

  • principal

  • Other cash outflows

Budgeting - Improving Your Cash Flow

In its simplest form, cash flow is the movement of money in and out of your business. It is most often described as the process in which your business uses cash to generate goods or services for sales to your customers, collects the cash from the sales, and then completes this cycle all over again.

The two basic elements of your business's cash flow are the cash inflows and cash outflows. Cash inflows are the movement of money into your business. Examples of cash inflows include cash collected from sales to customers, collections on accounts receivable, and the proceeds from a bank loan or other types of loans. Cash outflows are the movement of money out your business. Examples of cash outflows include paying expenses, purchasing property or equipment, and paying back a bank loan or other types of loans.

Most grantmakers will request both a general operating budget and special project budget (if applicable). Budgets are cost projections. They are also show the funder how your project will be implemented and managed. Good budgets reflect carefully planned projects.

This is a sample general operating budget.

Budget Purpose:

  ____ General Operating Support

  ____ Project Support

Budget Period:












General Operating Support


Government grants & contracts


Salaries & Fringe Benefits (for project budgets detail each position to be funded)


Banks & Foundations


Salaries, Fringe & OTPS


Earned Income


Salaries, Fringe & OTPS




Insurance & taxes




Consultants & professional fees


In-kind support


In-kind expenses






Detail OTPS Expenses


Subtotal OTPS Expenses


Banks & Foundations




Earned Income




Earned Income


Printing & copying


Earned Income, Banks & Foundations


Telephone & fax


Earned Income, Banks & Foundations


Postage & delivery


Earned Income


Rent & utilities


Other Income (specify)


Other Expense (specify)


Other Income


Other Expense (specify)


Other Income


Other Expense (specify)








NET INCOME (income less expense)



A strong Business Plan may not guarantee success; but it could certainly prevent failure!

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