Reliable Business Budget Percentage Breakdown
Serving as a bill of health for your business, your budget provides insights into your revenue, expenses, and cash flow. However, understanding if your company is in good health based on these numbers can be difficult and many small business owners often find themselves scratching their heads as to what percentage of their revenue should be allocated to categories such as operating expenses, taxes, and even their own compensation.
Assigning budget percentages can help you understand not only how your business is performing year-over-year, but where you can make cuts (if needed), and where you can increase spend. In this post we will focus on guidelines that can help you determine how best to assign percentages to your various business budget categories.
Is there a Magic Number?
Small business finance expert Mike Michalowicz developed Profit First, a methodology that states business owners need to allocate income and prioritize profit prior to paying expenses. The Profit First system highlights that business expenses should be no more than 30% of total revenue.
He suggests that this strategy will ensure profitability and if there isn’t enough leftover after profit and compensation to cover expenses, then expenses should be cut. Michalowicz advocates for having a separate bank account for the categories of income, profit, owner compensation, taxes, and operating expenses.
While we love the Profit First methodology, we understand that business budgeting isn’t a one-size-fits-all scenario, and depending on the age of your company (start-up vs. mature) or type of business (online vs. brick and mortar), you will likely have different budget categories to support your business plan.
Small Business Budget Percentage Breakdown Guidelines
Breaking down your budget by percentages is a great way to set financial goals, understand cash flow from the last year, and plan for next years’ business needs.
Increased revenue is obviously a financial goal for every organization; however, other common goals that you may set for your company can include better profit margins, decreased costs, and improved cash flow.
By assigning percentages to these various categories, you can easily have a soup-to-nuts comparison over previous years and see where you are tracking against your goals.
Previous Year Cash Flow
If assigning percentages to your budget is new for your business, we highly recommend taking the time to do a retrospective review of your business budget and financial statements over the last year or few years and calculate percentages for your various categories. These will serve as a quick-reference as you work on financial goals and review progress.
Next Year Business Needs
When determining the percentages for various budget categories, look at your business history, profit & loss statements, anticipated sales revenue, and industry trends. You also need to think about market factors and price fluctuations from vendors for parts and inventory.
Typical Allocation Percentage Guidelines
It’s important to reiterate that business budget categories aren’t one-size-fits-all, but there are a few categories that are frequently used. Here’s a quick rundown:
Small Business Operating Expenses
You likely have a list of required equipment for employees to do their work. This can be as simple as a laptop and cell phone, printer, paper, and ink. Or, maybe it requires expensive, highly specialized tools. Regardless of the scenario, it is important to assign a percentage to this spend category so that you can ensure you aren’t blowing your budget out of the water and you will be able to compare year-over-year operating expenses. As noted above, the Profit First system highlights that expenses should be no more than 30% of total revenue.
Fixed costs like leases can consume a large portion of your budget. According to experts, “Depending on what you’re selling, the standard gross-to-rent percentage can range anywhere from less than 1 percent all the way up to more than 13 percent, with most industries paying below 10 percent.”
The math to calculate what percentage of your revenue goes to rental fees is quite straightforward:
- Determine how much you spend annually on rent
- Divide your annual rent by your gross annual income
For instance, if you pay $100,000 a year in rent, and your income is $2 million, your rent equals 5 percent of your income. To simplify further, for every dollar your company makes, five cents will go toward your lease.
Variable costs are expenses such as utility bills, credit card fees, and meals. While the expense exists with each billing cycle, the amount will change from month-to-month. Look at what you’ve spent in previous years and determine the percentage. From there, you can baseline the percentage you assign to variable expense categories and monitor as needed.
Similar to rent, the amount you spend on employee compensation can consume a large chunk of your operating costs. As noted by experts, “If you spend between 15 and 30 percent of your gross revenue on payroll, your business is likely in solid standing.”
Do your research and benchmark industry standards — again, this number won’t be the same for every business.
Financial Analysis and Business Health
The bottom line is that no two small businesses are exactly alike and often owners have different processes or ways of budgeting. Regardless of the variables, certain constants are found in almost every budget scenario.
Remember that your budget should be your roadmap, helping you to understand what percentage of your income needs to be allocated to categories such as taxes, operating expenses, inventory, rent, and even your own compensation in order to meet your business goals.
We hope you found this guide helpful. If you have further questions about budget percentage breakdowns for your small business, the TravelBank team would love to hear from you.