Use Historical Data as a Guide
The first step in building a budget is analyzing your financial reports. If your bookkeeping is not updated then you have a problem. In order to build a budget you will need a proper bookkeeping system that is updated and accurate.
When looking at your financial data can you spot any trends? What do your sales growth rates look like and are they trending in a predictable manner? What about the expense side of your business? Do you see any trends or things that stick out? What you want to do is just look for trends and ask yourself some of these questions. Don't start building your budget yet, just start by analyzing the data.
The expense side of the budget is the only true thing you have complete control over. While you can influence sales you can't automatically increase them. You can make a decision to cut certain expenses and then make sure it gets done. Are there any new expenses that you are expecting or are there some going away? If so, make a note of those changes and what you are expecting to happen. You really want to look for red flags of expenses that you want to change or monitor. If something seems high then make a note of it.
Where Do You Want to Be?
One critical question you need to ask yourself when building a budget is where do you want to be next year? How about in 3 and 5 years time? I think one mistake that people make when building a budget is relying too much on forecasting. If you know you have a significant opportunity in your market that will result in a large sales increase, work that expectation into your budget. Your budget needs to be about desires as well as logic based on historical data.
Blend Logic and Desires
If you have followed the above process you are now ready to start working on building your actual budget. You now need to take your predictions based upon historical data analysis and blend it with the numbers you desire. If you know you are taking on a new expense or cutting one completely make sure to note that. I always aim for my budget to be logical but also aggressive. You don't want to make your budget simple to hit, but you also don't want to make it unattainable. Blend logic and your desires to come up with your budget.
Use Budget as a Tool
After you have gone through all of this trouble to develop a budget make sure to actually use the budget. In order to use your budget as a business tool you need to enter the budget into Xero (your accounting software). So many business owners spend a lot of time and resources to develop a budget and then never even look at it again. The budget gets filed away and is never reviewed. It is important to enter your budget into Xero so you can do budget v actual comparisons throughout the year. I always recommend that you enter your budget into Xero on a per month basis. I would recommend looking at budget v actual numbers at least once per month if not more.
A Budget is a Guide
Another mistake I see business owners make is acting like the budget is the be all and end all for the business. A budget is nothing more than a guide and it needs to be flexible. If there is a major change in your business that affects your budget then you need to note that change or adjust the budget. You may also face adverse changes in the law that will have a major effect on your budget. A budget is a guide and should keep you on track toward your goals. Things may come up that are out of your control and there is not much you can do about that. What you can do is monitor your actual results v your expected results to look for glaring discrepancies. You can then make the necessary adjustments to get back on track.
Build your Budget Prior to Year-end
The last thing I wanted to mention is that you should build your budget prior to year-end. I would say you should start thinking about your budget in Q4 and aim to have it completed a few weeks before your new-year starts. You should then enter it into your accounting system and hit the ground running towards your goals rather than trying to define what your goals are.