META TITLE: How to Set Up a Budget for Your Business | Guide

How to Set Up a Budget for Your Business

The contractor made $780,000 last year. He had no idea where $340,000 of it went.

He could account for materials. Payroll was trackable. But the middle - fuel, tools, repairs, insurance, the truck payment, the accountant, software subscriptions - blurred into a mass of expenses that seemed to grow every month. When I asked about his target profit margin, he said "whatever's left."

That's not a budget. That's hope.

A budget forces clarity. It tells every dollar where to go before it arrives. Without one, money disappears into spending that feels necessary in the moment but adds up to margin destruction over time.

Why Most Business Budgets Fail

The typical approach: estimate revenue, list expenses, subtract. If the number is positive, proceed. If negative, cut something.

This fails because it treats all expenses equally. Rent and a software subscription appear on the same list with the same weight. But rent is fixed and the software might generate nothing. The budget doesn't distinguish between expenses that drive revenue and expenses that just consume it.

The second failure: annual thinking. A budget set in January and ignored until December misses the reality that business conditions change monthly. The contractor's fuel costs spiked 34% mid-year. His budget didn't account for it. His margins absorbed the hit silently.

Your Margin Temperature - the vital sign tracking your profitability health - depends on expense control. A budget is the control mechanism.

The Revenue-First Framework

ACTION: Start with conservative revenue projections. Take last year's monthly revenue and reduce it by 10%. This is your baseline.

The contractor's actual monthly breakdown: January $48,000, February $52,000, March $71,000, April $89,000, May $94,000, June $88,000, July $76,000, August $82,000, September $79,000, October $68,000, November $54,000, December $59,000.

With 10% reduction applied, his January budget assumes $43,200 in revenue, not $48,000. Building on conservative projections means surprises tend to be positive.

ACTION: Categorize all expenses into four buckets.

Fixed costs: Same amount every month regardless of revenue. Rent, insurance, loan payments, base salaries. The contractor's fixed costs: $18,400 monthly.

Variable costs: Grow directly with revenue. Materials, production labor, shipping, credit card processing fees. For the contractor: roughly 42% of revenue.

The Percentage Allocation Model

Most healthy businesses follow rough allocation percentages. These vary by industry, but benchmarks help identify problems.

Net profit target: 10-20% of revenue

The contractor's actual allocation: COGS 42%, labor 31%, overhead 16%, marketing 3%, profit 8%. His overhead ran high - he was paying for 3,200 square feet of shop space but using 1,800. That extra $1,400 monthly in unused space cost him $16,800 annually, more than his discretionary spending.

ACTION: Calculate your current allocation percentages. Compare against industry benchmarks. Any category 5+ points above benchmark needs investigation.

Building the Monthly Budget

ACTION: Create a budget spreadsheet with these columns: Category, Budgeted Amount, Actual Amount, Variance, Variance %.

For each expense category, set monthly limits based on your allocation targets.

Profit target (10%): $6,500

Any month where actual expenses exceed budgeted amounts by more than 10% triggers review. Any category consistently over budget for 3+ months requires structural change - either the budget was unrealistic or spending is out of control.

The Expense Audit Protocol

ACTION: Review every expense and ask three questions.

Question 1: Does this directly generate or protect revenue? If yes, keep it. If uncertain, track the connection for 90 days.

Question 2: What happens if we eliminate this for 30 days? Some expenses seem essential until you test living without them. The contractor had three software subscriptions for scheduling. He used one. The other two cost $89 monthly combined and added nothing.

Question 3: Can this be reduced by 20% without impact? Many expenses expand to fill available budget. The contractor's truck maintenance budget was $600 monthly based on dealer recommendations. Switching to an independent mechanic cut it to $380 with identical service quality.

The Monthly Variance Meeting

ACTION: Schedule 30 minutes on the 5th of each month to review the previous month's actual vs. budgeted spending.

Focus on variances greater than 10%. For each, identify: Was this expected or surprising? Was this a one-time event or recurring pattern? What action prevents this next month?

The contractor discovered his fuel costs spiked in months with distant job sites. By mapping job locations against fuel expenses, he added a $0.02 per mile fuel surcharge to bids more than 25 miles from his shop. This converted a margin leak into a pass-through cost.

Tracking your Cash Pulse alongside budget variance shows whether overspending comes from operational needs or discipline failures. High revenue with high overspending might be acceptable growth investment. Low revenue with high overspending is crisis.

The Contingency Buffer

ACTION: Budget for unexpected expenses at 5% of revenue.

The contractor's $780,000 annual revenue should have included $39,000 in contingency budget. Instead, every unexpected expense came from margin. When his truck transmission failed ($4,800), it ate two months of profit because no buffer existed.

Build contingency into the budget as a line item, not an afterthought. If the contingency isn't used, it becomes additional profit. If it is used, you've already accounted for it.

The Quarterly Budget Review

ACTION: Every 90 days, review budget allocations against actual results and adjust for the next quarter.

Questions for quarterly review: Which categories consistently underspend? (Reallocate or reduce targets.) Which categories consistently overspend? (Increase allocation or reduce spending.) Has revenue trajectory changed the percentage math? (Adjust all percentages accordingly.)

The contractor's Q2 review revealed that marketing spend dropped to 1.8% because he was too busy to pursue new clients. Good problem in the short term. Dangerous in the long term. He reallocated marketing budget to hiring a part-time estimator, freeing his time to pursue larger contracts.

Budget vs. Forecast

A budget sets targets. A forecast predicts outcomes based on current trajectory.

Run both. Your budget says you want 10% profit margin. Your forecast says you're trending toward 6%. The gap between them identifies the problem and quantifies the urgency.

The Decision Point

You can operate without a budget and wonder why profitable-looking years leave no cash in the bank. You can build a budget in an afternoon, track it in 30 minutes monthly, and know exactly where every dollar goes and whether it earned its keep.

The contractor rebuilt his budget using this framework. Year two, same revenue: $780,000. Margin: 14.2% instead of 8%. The $48,000 difference didn't come from working harder. It came from watching where money went and stopping the leaks.

ACTION: If using accounting software, configure your budget in the system this week. Run your first budget vs. actual report. If the report is hard to read or missing categories, fix the configuration before next month.

Some businesses use separate budgeting tools - Adaptive Planning, Planful, or even Google Sheets with custom templates. For most small businesses, this adds complexity without proportional benefit. Start simple. Add sophistication only when simple proves insufficient.

For businesses without accounting software, a monthly spreadsheet comparison works. Columns: Category, Budget, Actual, Variance, Variance %. Conditional formatting highlights variances exceeding thresholds. The discipline of monthly update matters more than sophistication.

Accounting software handles budget-to-actual comparison automatically. QuickBooks, Xero, and similar platforms allow budget entry and generate variance reports. The reports matter more than the software.