To keep track of your business’s finances, you have to establish solid budgets. You should have both an income budget and a liquidity budget. Let’s take a look at how to make these.
Budgeting is one of the most important things you can do for your business. Budgets are excellent management tools; once you’ve created a budget, you’ll know when and where to make changes to keep your business running, and you’ll also be able to identify opportunities for growth.
Save money in your budget with free invoice software
With Conta, you get all the benefits of professional invoice software—for free. It’s quick to set up and so easy to make invoices that you can get paid in no time! All your invoices are safely stored and you can easily follow up on payments and get control of your cash flow.
How to create a budget: Which budgets do you need?
You should prioritize setting up an income budget, also known as an operating budget, and a liquidity budget. The income budget shows the result after a set period, while the liquidity budget ensures that you have funds to cover upcoming expenses. If you have control over both your income and your liquidity, your business has a solid foundation.
Well-maintained financial records are a good starting point for budgeting. If you’ve been in business for a while, you can use last year’s figures to set up your budget. If you’ve just set up your business, you can create budgets based on the costs of producing your goods or services, estimate expenses you’ll have like vendor bills, rent, salaries and software, and look at your pricing strategy and your margins.
It pays to be realistic, even pessimistic, when setting up a budget. If you budget with slightly higher costs and lower income than you expect, it’ll help you avoid unpleasant surprises.
Pro-tip: Save money on software with free invoicing
To reduce expenses in your budget, you should look for cheap or free options. There are, for example, many free tools that can help you establish a brand.
Invoicing is important because it’s how you get paid for your products or services. With Conta you can send invoices for free. Get paid on time while cutting costs—it’s a win-win.
What is an income budget?
You should start with an income budget because the figures can be used to set up your liquidity budget.
In an income budget, you compare expenses against income over a period of time. The results shows whether your business is profitable and gives you an idea of how much tax you’re going to pay.
Usually, income budgets cover a calendar year, but you can also set up an income budget for a shorter period.
How to create an income budget
You can calculate the income budget like this:
Profit = revenue – expenses
Under revenue, list everything you expect to earn in the given period, while under costs of goods sold and operating expenses, list everything you expect to spend. Common costs include, for example, what it costs to produce goods and services, wages, advertising, and insurance. Put small expenses like mobile plans under «Other expenses.”
Ready to take control of your finances? Start budgeting with our budget template.
Pro-tip: Budget correctly
Note that income and costs in an income budget should be listed in the month they are invoiced, not the month they are paid. For example, if you purchase a printer in January and you pay the invoice in February, the printer cost should be assigned to January.
What is a liquidity budget?
The easiest way to check whether your business has enough money to pay bills every month is by setting up a liquidity budget.
While the income budget shows planned income and costs, the liquidity budget shows estimated receipts and estimated payments over a period—when money actually comes into and goes out of your account. Ultimately this budget reflects your business’s liquidity and payment capacity.
The advantage of a liquidity budget is that you can easily see periods when you’ll have a surplus of cash and periods when you might have too little money. This helps you plan expenses accordingly, and for example, postpone big purchases to periods with better liquidity.
You can set up a liquidity budget for whatever period you require. It depends on your plans. If, for example, you plan to invest in new equipment for your business in the next three months, you can create a budget to find out when you can afford to make that purchase. It might be a good idea to create a budget for slightly longer than three months as well, in case there are big upcoming costs.
It’s also a good idea to set up a liquidity budget for the first year you run your business. This way, you can easily determine whether you’ll manage with the expected funds and income or if you need to find more ways to make money or price your products and services differently.
Banks might also require a liquidity budget if you’re applying for a loan or seeking a credit line.
See also: The ultimate guide to liquidity and cash flow
How to create a liquidity budget
You can calculate liquidity reserves in this way:
Liquidity reserves = estimated receipts – estimated payments
Add what you expect to have in your account at the beginning of the month. Then enter the estimated receipts and payments for that month. At the bottom you’ll see what you’ll have in your account at the end of the month.
Your income budget and liquidity budget will look different. This is because income and receipts aren’t the same thing: if you invoice a client in January, you add it to your January post in your income budget, but if you receive the money in February, you add it to your February post in your liquidity budget.
That’s why you should have both, the income budget shows if you’re making money, the liquidity budget shows if you have enough money to cover costs.
Another way to figure out if your business has good liquidity is by finding the liquidity ratio. Here’s how you calculate the liquidity ratio.
Good luck with your budgeting!
