Building a Budget for Your Small Business

November 09, 2013 : Mike Slack

ED Note: This is the second in our Small Business Saturday series. In the first installment we looked at setting up your small business for tax purposes.  This week’s post digs into the basics of small business budgeting, why it is important and what to consider as you get started. 

A solid budget is often the backbone of a business’ future success. However, creating a budget is tough when a business is first starting, and difficult to stick to even at the best of times.

Estimating your business’ future revenue and expenses via a budget and sticking to it is important because it helps a small business look past the short-term and determine whether it will have enough money to operate, expand, and ultimately be successful. Without an adequate budget, a business exposes itself to overspending and leaving its coffers dry for the future, or not spending enough and hinder its growth and competitiveness.

In a budget, you need to include projected revenue, typically on a monthly basis. An already established business can budget for its revenue based off of historical information, but for a new business, the process isn’t as easy. Owners often must make assumptions based off of similarly situated businesses in their area.

When budgeting for expenses, the business must take into account three types of expenses.

  • Fixed Costs – These are expenses that do not change in the short-term, regardless of the business’ activity. They include amounts such as rent, salaries, mortgage payments, and property taxes.
  • Variable Costs – These are expenses that vary directly with the business’ sales or activity. One example is inventory expense, where the more inventory a business sells, the higher the business’ variable costs are.
  • Mixed Costs – Also called “semivariable” costs, these are expenses that are both fixed and variable in nature. For example, a telephone bill may include an amount for a monthly fee to use the service and an amount that is determined based on the telephone’s usage. The monthly fee must be allocated to fixed costs, while amount based of off usage is allocated to variable costs.

How often should the budget be reviewed or updated?

That depends. Large businesses and already established small businesses typically review their budgets annually. Small businesses starting out should take a more dynamic approach and review their budgets more frequently, sometimes often as month or two ahead to account for the unexpected nature of entrepreneurship.

Budgeting for Income Taxes

While budgeting for your business’ income and expenses can be a challenge, budgeting for taxes is simpler because the amounts you will have to pay are typically tied to profits, rather than market forces. Taxes paid by a business for a year are not susceptible to unforeseen events as the applicable rates and calculations are typically set by the federal and state governments prior to the beginning of the year. That being said, the amount budgeted for taxes should be reviewed at least annually to reflect changes in laws and a business’ profits; and possibly more often than that if the business’ income fluctuates significantly during a year.

Budgeting for Payroll Taxes

Taking into account the costs of paying your employees is crucial, and costs much more than just their wages. The taxes most employees see withheld from their wages are already taken into account when you budget for their base wages. However, employers are also required to pay the “employer’s portion” of certain taxes and benefits that are not deducted from the employee’s paychecks.

  • For example, if you pay an employee $40,000, in addition to the amounts deducted from the employee’s paychecks, the employer must also pay an additional $3,060 for social security and Medicare taxes, which is equal to 7.65% of the employee’s wages, to the IRS.

In addition to social security and Medicare taxes, an employer must also pay state and federal unemployment taxes. State unemployment tax rates and limits vary from state-to-state mostly depending upon the status of the employee. While the federal unemployment rate generally equals 6% less the percentage paid for state unemployment tax, subject to a maximum of $420 per employee. 

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Mike Slack

Mike Slack

The Tax Institute, H&R Block

Mike Slack, JD, EA, is a senior tax research analyst at The Tax Institute. Mike leads research teams focused on business and investment tax issues.