A small business budget is a plan, written in dollars, for what the business expects to earn and spend over the next year. It does not have to be complicated or perfectly accurate to be useful. Its real value is that it sets a benchmark: each month you compare what actually happened with what you planned, and the differences tell you where to look. This guide shows how to build a simple annual budget from last year's numbers, how to review it every month, and why you also need a separate view of cash.
Start with last year's actual numbers
The best starting point is not a blank spreadsheet but last year's profit and loss statement. It shows what revenue and each cost actually were, which is far more reliable than estimates from memory. If your books are behind, catch them up first; our small business bookkeeping guide covers the routine that keeps them current.
Go through last year line by line and ask three questions:
- Was anything one-off? A large repair, a legal fee or a one-time contract should not be copied into next year unless it will happen again.
- Is anything missing? A new hire, a new lease or a planned software subscription needs its own line.
- What will change in price? Rent increases, insurance renewals and supplier price lists are often known in advance.
If the business is new and has no history, build each line from quotes, leases and your hiring plan, and expect to revise more often in the first year.
Then forecast revenue
Revenue drives most of the budget, so forecast it carefully and conservatively. Rather than adding a round percentage to last year, build it from its parts. Take a business that sold $600,000 last year:
| Revenue build | Amount |
|---|---|
| Existing customers expected to stay (95% of $600,000) | $570,000 |
| 3% price increase on that retained revenue | $17,100 |
| New customers from planned marketing | $72,900 |
| Budgeted revenue | $660,000 |
Each line can be questioned and tested. Is 95% retention realistic? Will customers accept the price increase? How many new customers does $72,900 represent, and does the marketing budget support that? A forecast built this way is easier to defend, and easier to adjust when one assumption proves wrong. If sales are seasonal, spread the annual figure across the months in the same pattern as last year rather than in twelve equal parts.
Fixed costs, variable costs and payroll
Next, sort costs into two groups, because they behave differently when sales change.
- Variable costs rise and fall with sales: materials, stock you resell, shipping, sales commissions and card processing fees. Budget them as a percentage of revenue, based on last year's actual percentage.
- Fixed costs stay roughly the same whatever you sell: rent, insurance, software subscriptions, most salaries and loan interest. Budget them as dollar amounts.
Payroll is usually the largest cost after materials, and it is easy to understate. Budget it as one line covering the full cost of employing people: gross wages, the employer's share of payroll taxes, and benefits you pay for. Do not try to calculate payroll taxes yourself for the budget; ask your payroll provider or accountant for a report of last year's total employer cost, then adjust for planned raises and new hires. Remember that a new hire in July costs only half a year.
Owner pay
How owner pay appears depends on how the business is set up. In a sole proprietorship or partnership, owner draws are not an expense; they are a withdrawal of equity, so they belong in the cash budget, not the profit budget. If you are an employee of your own corporation, for example an S corporation owner who takes a salary through payroll, that salary is an expense and belongs in the profit budget. Either way, budget a realistic amount. A business that only "makes money" because the owner is unpaid is not yet covering its costs. The IRS explains who needs to make estimated tax payments, which also need cash set aside.
A simple annual small business budget
Here is a complete annual budget for the same business, next to last year's actuals. Cost of goods sold is a variable cost at 40% of revenue in both years; the owner is paid a salary through payroll and shown on a separate line.
| Line | Last year (actual) | This year (budget) |
|---|---|---|
| Revenue | $600,000 | $660,000 |
| Cost of goods sold (40%) | $240,000 | $264,000 |
| Gross profit | $360,000 | $396,000 |
| Payroll (wages, employer taxes, benefits) | $180,000 | $192,000 |
| Owner salary | $60,000 | $60,000 |
| Rent | $36,000 | $37,800 |
| Utilities and phone | $9,000 | $9,600 |
| Insurance | $8,000 | $8,400 |
| Marketing | $18,000 | $24,000 |
| Software and subscriptions | $6,000 | $6,600 |
| Accounting and legal fees | $7,000 | $7,200 |
| Other expenses | $6,000 | $6,000 |
| Total operating expenses | $330,000 | $351,600 |
| Net profit | $30,000 | $44,400 |
Check the arithmetic. Gross profit: $660,000 − $264,000 = $396,000. Operating expenses: $192,000 + $60,000 + $37,800 + $9,600 + $8,400 + $24,000 + $6,600 + $7,200 + $6,000 = $351,600. Net profit: $396,000 − $351,600 = $44,400. Last year: $360,000 − $330,000 = $30,000. The budget plans for more profit mainly because revenue grows faster than fixed costs, which is worth questioning before you commit to it.
Monthly budget vs. actual review
A budget filed away in January does nothing. Its value comes from a monthly comparison once the books are closed; our month-end close checklist covers getting the numbers ready. Divide each annual line by twelve, or use your seasonal split, and compare it with the month's actual results. Here is March, with variances marked F (favorable to profit) or U (unfavorable). The five smaller lines are combined as "Other operating costs."
| March | Budget | Actual | Variance |
|---|---|---|---|
| Revenue | $55,000 | $51,000 | $4,000 U |
| Cost of goods sold | $22,000 | $21,420 | $580 F |
| Gross profit | $33,000 | $29,580 | $3,420 U |
| Payroll | $16,000 | $16,900 | $900 U |
| Owner salary | $5,000 | $5,000 | $0 |
| Rent | $3,150 | $3,150 | $0 |
| Marketing | $2,000 | $2,600 | $600 U |
| Other operating costs | $3,150 | $3,050 | $100 F |
| Total operating expenses | $29,300 | $30,700 | $1,400 U |
| Net profit (loss) | $3,700 | ($1,120) | $4,820 U |
The figures tie out: the $3,420 gross profit shortfall plus the $1,400 of extra operating costs equals the $4,820 profit shortfall. The monthly budget is one-twelfth of the annual one: $660,000 ÷ 12 = $55,000 revenue, $351,600 ÷ 12 = $29,300 of expenses, and $44,400 ÷ 12 = $3,700 profit.
Now read it. Revenue was $4,000 short. Cost of goods sold looks favorable, but only because sales were lower; at the budgeted 40%, $51,000 of sales should have cost $20,400, so the actual $21,420 is $1,020 more than expected, a margin problem worth investigating, perhaps a supplier price rise or heavier discounting. Payroll was $900 over, which might be overtime. Marketing was $600 over, which is fine if it brings in April's sales. For each large variance, decide whether it is timing that will reverse or a lasting change that should be reflected in your forecast.
Cash budget vs. profit budget
The budget above is a profit and loss budget, built on the accrual basis. It does not tell you whether you will have cash in the bank, because profit and cash move at different times. Customers pay after you invoice them, stock is paid for before it is sold, and some payments, such as equipment, loan principal and owner draws, never appear as expenses. Our article on the cash flow statement explains these differences in detail.
A cash budget lists the cash you expect to collect and pay each month. Here is one month:
| Cash budget, one month | Amount |
|---|---|
| Opening cash | $20,000 |
| Collections from customers | $50,000 |
| Payments to suppliers | ($23,000) |
| Payroll, including owner salary | ($21,000) |
| Other operating payments | ($8,300) |
| Equipment purchase | ($6,000) |
| Loan principal repayment | ($1,500) |
| Net change in cash | ($9,800) |
| Closing cash | $10,200 |
Cash out totals $23,000 + $21,000 + $8,300 + $6,000 + $1,500 = $59,800, against $50,000 collected, a net change of −$9,800, leaving $20,000 − $9,800 = $10,200. A month like this can be perfectly profitable and still leave the bank balance uncomfortably low. Seeing it in advance lets you delay the equipment purchase, chase collections or arrange a line of credit before you need it.
Adjusting the budget mid-year
Most businesses keep the original budget unchanged as the yardstick, and maintain a separate forecast that is updated each quarter for the rest of the year. That way you can still see how far you have moved from the plan, while making decisions on the latest numbers. Reforecast when something material changes: you lose a large customer, win a big contract, add staff or face a significant cost increase. Do not rewrite the budget every month to make the variances disappear.
Common small business budget mistakes
- Optimistic revenue, precise costs. Costs are usually certain; sales are not. Build in caution where uncertainty is greatest.
- Leaving out irregular costs. Annual insurance, renewals and equipment replacement belong in the budget even if they are paid once a year.
- Understating payroll. Wages alone miss employer taxes and benefits.
- Ignoring cash timing. A profit budget without a cash budget can hide a shortfall.
- Never looking at it again. A budget without a monthly review is a guess, not a tool.
A small business budget works best when the numbers you compare against come straight from your books. BMS Prime includes budgeting alongside a double-entry ledger in US dollars, with profit and loss, balance sheet and cash flow statements for any period you choose. It does not calculate US payroll taxes or connect to bank feeds, so take payroll cost figures from your payroll provider and keep transactions entered. See how it fits together on our HR and accounting software page for US small businesses; accounting is included from the Growth plan up, and every plan starts with a free trial (pricing). The SBA's guidance on managing your business finances is a good next read, and if purchasing is a large part of your costs, our guide to the purchase order process shows how to keep that spending within budget.
Frequently asked questions
What should a small business budget include?
At minimum: a revenue forecast, cost of goods sold if you sell products, every regular operating expense such as payroll, rent, insurance, software and marketing, and the resulting profit. Alongside it, keep a cash budget that adds the items the profit budget leaves out, such as equipment purchases, loan principal, owner draws and the timing of customer payments, so you can see whether you will have enough cash each month.
How often should I compare my budget to actual results?
Monthly is the usual rhythm, once the books for the month are closed and the bank accounts reconciled. Compare each line, investigate the large differences, and note whether each one is timing or a lasting change. A quarterly reforecast of the rest of the year is a sensible addition, and a business with tight cash may want to check the cash budget weekly.
What is a good variance threshold to investigate?
There is no single rule. Many businesses set a threshold that combines a dollar amount and a percentage, for example a difference of more than $500 and more than 10% of the budgeted line. Small lines can swing by a large percentage without mattering, and large lines can matter at a small percentage, so the dollar test keeps attention on what affects profit and cash.
What is the difference between a budget and a forecast?
A budget is the plan you set at the start of the year: what you intend to earn and spend. It usually stays fixed so you can measure performance against it. A forecast is your current best estimate of how the year will actually end, updated as results come in. Many businesses keep the original budget for comparison and update a rolling forecast each quarter.
Should owner draws be included in the budget?
In the cash budget, yes, because draws take real money out of the business. In a sole proprietorship or partnership, draws are not an expense, so they do not belong in the profit and loss budget. If you are paid a salary through payroll, for example as an S corporation owner-employee, that salary is an expense and goes in the P&L budget too.
Read next
- HR & accounting software for US small businesses
- Cash flow statement explained for small business owners
- Small business bookkeeping guide
- Month-end close checklist
- The purchase order process for small businesses, step by step
- Plans and pricing