By Lior Ronen | Founder, Finro Financial Consulting

Proper budget planning and tracking are the most effective tools to control a startup's burn rate or a small business's cash flow.

There are many different ways to build a business budget. 

In this post, I'll cover the entire budgeting process and the popular budget methods that apply to startups and medium-sized businesses. 

Business Budget Methods

There are many budgeting methods and many ways to plan annual business expenses. For example, most large corporations have their methods and process for business planning. However, I want to focus on three standard budgeting methods that are intuitive and simple to build and maintain: fixed-variable budget, activity-based budget, and zero-based budget.

The Fixed-Variable Budget

This method breaks down the business expenses into three groups: fixed, variable, and semi-fixed. 

Generally speaking, a cost is fixed or variable if it fluctuates with the number of products sold. 

Fixed costs are expenses a business pays no matter how many products it sells. Typically these costs include advertising and marketing costs, research and development expenses, rent, insurance, interest rates, depreciation, accounting, and legal services fees.

Variable expenses fluctuate with the number of units sold, items that fall under the cost of goods sold (COGS), which are the expenses that directly help you bring your product to the client and especially in ent to use them of goods sold allow your client. 

In SaaS and cloud-based business, AWS costs and payment processing fees are typical examples of variable business costs. In eCommerce businesses, product costs and shipping are added to the variable costs list on the top of the AWS and payment fees. 

Semi-fixed (or semi-variable) costs are fixed to a specific sales volume level and variable above that line. This category could theoretically include all the examples above if they are set until a certain level of sales beyond that line in a particular company and variable b. 

This is an acceptable budget method for businesses with unstable revenues that need to add and control their fixed costs carefully. However, it might add complexity for many small business owners, making the activity-based budget more relevant. 

The Activity-Based Budget

In this method, we break the small business budget according to the different activities in the business. This is a powerful method because of the freedom and flexibility it provides entrepreneurs when planning their budgets. 

They can break down the annual or monthly budget into products, features, or even milestones to reflect its roadmap, making it easy to prioritize activities and the amount of money attached. 

Alternatively, we can break down the budget to the different activities in the business like post-sales engineering, marketing campaigns development, new product development, sustaining growth, etc.

It's essential to include all the expenses in every activity, both payroll and non-payroll expenses. 

This budgeting method is very effective in analyzing the cost of different activities in the company, depending on the metrics you choose to use. 

Zero-Based Budgeting (ZBB) Method

The ZBB method is widespread in large corporations but can also be implemented successfully and efficiently in small businesses.

The ZBB method assumes the business will not grow its operating budget year-over-year. In traditional budget methods, budges may include a fixed annual increase of 2% to 5% or an unexpected expenses category to cover any unknowns. 

However, in the ZBB method, the company build assumes no annual growth, and every activity must be justified thoroughly. When using the ZBB method, the company's financial goals lead the process, and every new action needs to support that. 

In this method, new activities do not necessarily increase the budget. Instead, the company finds creative ways to absorb them in its existing budget by finding areas for improvement or cash-saving opportunities. 

​Building a Budget Target

Before the preparation work, the business needs to lay down its boundaries for the budget and the basic framework for the process. 

The most common method of building a budget framework is balancing the expected revenue growth and the desired bottom line or operating profit next year. What does that mean?

A business needs to consider four different elements when setting its budget target for next year:

1. Revenues: the company needs to build a detailed assessment of next year's revenues. That would help us understand our expected incoming cash flow and determine how much a business could spend. 

2. Fundraising: this is especially relevant for startups that raise external funds to fund the company's operations. If the company raises new funds, it will increase its incoming cash flow and could mean the business has more money to spend, therefore expanding the budget target for next year.

3. Business loans: while revenues and fundraising helped to determine the expected incoming cash flow, considering the company's balance sheet liabilities could help determine the necessary spending the business has to make. So repayment of business loans could potentially decrease the available budget for next year.

4. Other types of budget: another factor that could limit the budget target for next year is the additional funds the company needs to keep aside. So the business needs to consider whether it has enough money for its emergency fund or unexpected costs. In some cases, a business would need to increase these funds, decreasing the budget target even further. 

Preparation Before Building a Business Budget

The first step in building a budget for your small business is preparation. Of course, if this is a brand new business, this is not relevant, and you need to base all your estimates on expectations and projections.

While this post mentions costs and expenses and naturally focuses on the business' operating expenses, if you're looking at an overall cash flow budget, all the tools, methods, and processes can also be applied to budgeting capital expenditures (CapEx).

The starting point for next year's budget is the current or previous year's budget. 

To accurately estimate the operating expenses a business is expected to have in a particular year, we need to look at the costs the company usually has. Looking at the last year's data is a great reference point. 

The best place to start is in your QuickBooks, Xero, or whatever bookkeeping or accounting software you use, and download the most detailed operating expense report you have there to Excel. The more details you have in your baseline, the more accurate your budget planning will be. 

The second step is to analyze big-ticket items from previous years. Are they one-time spending or recurring expenses? Will they repeat next year? Are they top priority for the business success? What activity, product, or revenue line do they support? What is the impact on the business if they are delayed or canceled? Are there better alternatives for the service or product that could be more cost and operational effective to the company?

The third step is to analyze last year's budget if you have one, and measure how the business performed against it. If the company overspent or underspent in a specific category, try to understand what. Maybe it was a result of a one-time high priority spend. Perhaps the budget was too low or high. Insights from this could be valuable in building next year's budget. 

​Actually Building the Budget

Once we decide which budgeting method we use, consider all the different aspects when building a clear budget target, and complete the preparation steps, we can finalize a business budget template that supports our process, activities, and financial statements. We can add actions to next year's budget according to the guidelines and data gathered above. 

In this phase, we want to make sure that the business we build together, the subject matter experts, fully support the company's goals, roadmap, and milestones for the short and long term.