How to set an annual budget for your business

A budget sets next year's sales, costs and profit month by month, so that each month's management accounts can be checked against it. For most small businesses it takes a day or two, using last year's figures as the starting point.

1. Start from the profit you want

Decide what profit the business needs to make. Include what you will take out in salary and dividends, and what the business has to keep for Corporation Tax, loan repayments and anything you plan to buy. The rest of the budget works back from this figure.

2. Set the overheads

List the fixed costs month by month: rent, the wages of staff who are not doing the paid work, insurance, software, vehicles and finance costs. Put known changes in the month they happen, such as a pay rise in April when the National Living Wage goes up, a rent review or a new hire.

3. Work out the sales you need

Add the overheads to the profit you want, and divide by the gross margin percentage. The answer is the sales the business needs for the year.

If last year's sales were £650,000, the budget needs £100,000 more sales, a better margin, lower overheads or a mix of the three. At a 42% margin the sales needed fall to £714,286. The break-even calculator runs the same arithmetic.

4. Spread it across the year

Split the sales by month using last year's pattern, adjusted for the seasons, holidays and any contracts you know are starting or ending. Set direct costs at the budgeted margin for each month, and add the overheads from step 2.

5. Turn it into a cash flow forecast

The budget shows profit. A cash flow forecast moves each line into the month the money changes hands, and adds VAT, PAYE, Corporation Tax, loan repayments and equipment purchases. Build the two together, because a budget that makes a profit can still leave a month with too little in the bank.

6. Check against it every month

Each month's management accounts set the actual figures against the budget, line by line. For each difference that matters, write down what caused it (volume, price, margin, timing or a one-off) and what you will do about it. The budget stays fixed for the year, and the forecast is updated every month.