Machine learning in accounting is changing how startups manage their finances. Learn how it could apply to your business.
October 12, 2020
Creating an effective budget is crucial to setting your startup up for success. It's estimated that 65% of startup businesses aren't fully confident that they have enough money to start their new company, and a significant reason for this is a lack of adequate budgeting practices.
Whether you’re working through logistics of a budding business idea or you’ve already raised venture capital funding for your startup, a reliable startup budget is key to helping ensure the financial viability of your new venture. Without a clear understanding of your expected costs, the amount you need to succeed, and the amount of capital you have on-hand at any given time, you'll likely never be able to make the right financial decisions for your business.
If you're new to budgeting, you've come to the right place. Read along as we define the use cases and key elements of a startup budget, and walk you through each step to create an accurate budget for your startup.
The most straight-forward use of a startup budget is used to help business owners understand how much money they need to get their business off the ground, and how much money they require to cover expected business expenses over a period over time.
Founders are expected to provide an estimate of how much capital they need to bring their business to life and achieve key milestones. Budgets are a crucial element of a business plan, required to secure a business loan, and an integral part of your fundraising deck.
Each industry vertical has its own set of standard expenses and growth milestones. For example, here are a few milestones and related expenses for a SaaS business:
Once your startup is more established, your budget will serve as a tool to help analyze the impact and efficiency of your spending. Regularly comparing your budgeted costs to actual money spent, and taking this a step further to review outcome/result of your spend, is a helpful exercise for founders to test effectiveness of programs related to cost, and make informed, strategic decisions about how to invest in programs.
Creating a budget can be a daunting task if you’re new to the exercise. We’ve broken the process down step-by-step to help make it more approachable and ensure you don’t miss a thing while creating a working budget for your startup.
Fire up your computer, open a spreadsheet, and list out all the items required to start and grow your business during the first 12 months. Include big-ticket items like payroll costs, office space rent, equipment, trademarks, patents, and sales and marketing expenses; and smaller, day-to-day items, like cloud hosting fees, subscription softwares, office supplies, and business travel expenses.
Be specific about exactly what you need, providing as much clarity for each line item as possible. For example, don’t just include a line item for “Computers”, instead include a line for each specific item, such as “MacBook Pro x 3,” “Magic Keyboard x 3,” “Magic Mouse x 3,” — you get the picture.
When listing out your potential business expenses, make sure each line item includes an estimated cost for a 12-month period. If you’re unsure of the costs associated with an item on your list, do some research to make an educated estimate. Be generous in your estimates. It’s better to allocate extra funds for a line item than find yourself short on cash for an important business investment.
It’s commonly suggested startups pad their budgeted expenses by ~10% to secure your business against cash shortages or unforeseen circumstances. It’s also common for startups to underestimate costs of running a business; a few areas startups routinely under-budget for include:
Now that your long-tail list of expected costs are in place, it’s time to organize these expenses into three key categories:
Essential startup costs are those which are absolutely required to get your business up and running; without these items, you’d be stuck revving your engine at the starting line. These are typically one-time costs associated with getting your business off the ground.
Essential costs can vary significantly depending on the type of business you are starting; for most startups, they may include a mix of the following expenses:
Note: Most of the above essential startup costs are also considered fixed costs. For the sake of this budgeting exercise, we’ll break the essential startup costs out from the longer list of fixed costs to determine exactly how much capital your business will need on day one.
Fixed costs are the ongoing costs related to running your business; these costs persist regardless of sales or business performance. Again, depending on the industry of your business, fixed costs will vary. Basic fixed costs most startups should budget for include:
Variable costs are expenses that can increase or decrease relative to your business output or business priorities at a given time. Variable expenses may include:
Various income sources may contribute to your monthly revenues; the most common sources of income for startups include:
For new startups with no sales history, the best course of action is to refer back to the expenses you’ve estimated for the first year of your business, and work out how many sales you’ll need in order to cover those costs, aka break even.
Alternatively, founders can generate sales projections using market research related to the products or services they are selling, such as buyer personas, industry data and trends, and whatever other business intelligence may have inspired them to build their business in the first place.
Businesses with existing sales revenues can reference historical data from and previous sales figures to get an idea of what you can expect from sales in the coming 12 months.
Regardless of which approach you take, be sure to explore best- and worst-case scenarios for what your startup’s sales may look like so you can include realistic sales projections in your budget.
Capital from any funding sources, including personal assets from yourself and/or co-founders, angel investors, traditional venture capital firms, or bank loans, should be itemized in this section.
Many banks offer high-yield startup bank accounts where you earn a decent amount of interest from your savings or money market account balance. These earnings should also be reflected in the revenue section of your budget.
You’ve done the hard work of outlining the many items which will help determine the costs required to start and run your startup. Now it’s time to add them all up to find the starting point of your startup’s budget.
Calculate the sum of all costs outlined in your spreadsheet during Step 1 to find your annual budget; divide that number by 12 for your monthly business budget.
It’s possible this number is more than you had envisioned, or more than you have at your disposal. That’s ok, this is only the starting point. Now, we’ll go through a few exercises for adjusting your costs to arrive at a startup budget you’re more comfortable with.
Let’s revisit the work we did in Step 2 of categorizing your estimated startup expenses. Start by sorting your budget document to view variable costs first. Many of these items are ‘nice to have’, not ‘need to have’ expenses in the earliest stages of your startup. Go line by line and adjust these items based on business priority. Do you need to invest in an external marketing agency during year one, or would it be more cost effective to hire a consultant for a few hours a month? Is it necessary to invest in a fully fledged CRM program, or can you subscribe to a lower-tier service until you’ve reached a point where you need more bells and whistles?
Next, zero in on the fixed cost line items. Scrutinize these carefully and consider alternatives if any of these expenses appear to be pushing your budget beyond what’s reasonable.
Lastly, take another look at your essential startup costs. Review these line items carefully to make sure they are all, in fact, vital to getting your business off the ground. Make any necessary adjustments, but make sure you’re not arbitrarily adjusting any costs which may cause you to run into cash issues down the line.
Continue this exercise until you have arrived at a budget number that you, your business partners, your investors, and/or your board are comfortable with.
Take the total startup costs you calculated in Step 4, broken down by month, and compare them with your monthly revenue estimates. Are you generating enough revenue to cover business costs? If not, you must either refine your total costs further, or make a plan for securing additional capital to fuel your business.
Budgets are not a “set it and forget it” kind of business planning exercise. They should be revisited regularly, at minimum at the end of each month when you receive your financial statements (P&L or Income Statement, Balance Sheet and Cash Flow Statement) to review how your actual costs are tracking against your budget, and making any necessary adjustments as you go.
For early stage businesses that are purely in planning mode, using a spreadsheet to maintain your budget will do. We suggest Google Sheets so you can easily share, collaborate, and maintain your budget with your business partners and advisors.
Once your business has some financial infrastructure in place, such as bank accounts or corporate credit cards, we suggest accounting software to help automate some data entry, keep your business finances organized, and easily view your costs in relation to budget. We suggest Quickbooks Online, which makes it easy to track the in’s and out’s of your funds automatically. It’s reasonably priced, and you’ll need it eventually, so save yourself the time and hassle of manually updating spreadsheets by getting QBO up and running sooner than later.
See also: 8 Best Accounting Tools for Startups
If you're not sure how to proceed or are not comfortable creating a budget on your own, ask for help! At Zeni, we work with dozens of early- to growth-stage startups to manage their day-to-day business finances, including helping set and maintain budgets.
All customers gain access to a Zeni Finance Dashboard, which displays their company’s financial figures in interactive, real-time reports, such as operating expenses, net burn, revenue, cash position, and more.