How to Create and Manage a Startup Budget
Startup budgets are essential to understand your cash runway. Consider your one-off startup costs, fixed and variable costs, and estimated revenue, then refine your assumptions.
To avoid joining the failed startup statistic, you need to double down on your startup’s budgeting and plan expenses down to the details.
A startup budget helps to visualize your cash runway and plan your burn rate. Burn rate is a measure of how quickly your startup is churning through cash reserves. And it determines the length of your lifeline before you either raise funding, get profitable, get acquired, or go bankrupt.
The budgeting process enables you to balance all your fantastic targets with a realistic cash burn rate that’ll cover your startup costs, keep you operational—and growing. Planning your startup budget requires a good understanding of the costs of setting up, stabilizing, and running your startup day-to-day as you head toward profitability.
In this article, you’ll learn:
- What a startup budget is and how it works
- How to create a startup budget
- What to factor in when creating a startup budget, and
- How to optimize burn to increase your cash runway
Let’s get started.
What are your startup costs?
Startup costs are one-off expenses involved in creating a new business. Here’s a breakdown of the startup costs you should factor in planning your budget.
Company setup costs
Company setup costs include registration fees, legal fees, and the applications and requests you have to submit to relevant authorities before your startup is recognized as a legal entity.
Research and development
R&D costs feature both before kick-off and on an ongoing basis, i.e., as you build out your product or service offerings. Research and development costs include any funds you spend creating a business plan, carrying out market research, testing products, and interviewing users to improve your user experience.
Supplies and equipment
Supplies include new Macbooks, servers, vehicles, air conditioners, office supplies, furniture, physical inventory, and not forgetting a well-stocked kitchen. Supplies and equipment cover the hardware purchases planned for directly running or supporting your startup’s operations.
Here’s one area where startups throw in a significant part of their budget. Expenses like rent deposit, lease payments, utility connections are expenses made to acquire or maintain your startup’s business facilities.
Your tech stack goes here. Subscriptions, website creation, hosting, web development, and all the techy things you need to pay for to ensure your business runs smoothly.
Marketing budgets cover expenses involved with building your brand identity and creating awareness about your startup’s product or service offerings.
Your startup’s budget should also include insurance, license, permit fees, security deposits (for credit), etc. Assign any other uncategorized cost here.
Define your fixed and variable costs
The aim of running any business is to turn a profit. Even if you’re a public-benefit corporation, you need revenue to exceed expenses to stay afloat. And to turn a profit, you need to invest in your operations. That’s where fixed and variable costs come into the startup budget equation.
Fixed costs are expenses that remain relatively stable over time and don’t get influenced by the volume of business you process.
Some examples of fixed startup costs include:
- Lease or mortgage payments. Unless you move to a new facility, your startup’s lease or mortgage stays fixed
- Bank fees and payments on business loans. Similarly, bank fees and payments on loans tend to stay fixed unless you raise more debt funding.
- Utility payments, including internet, phone, electricity
- Website maintenance and hosting
- Professional services
- Technology subscriptions. This SaaS metric tend to stay fixed over time unless you require licenses for new employees.
Variable costs, on the other hand, tend to increase proportionally with your business volume, or discretionary spending.
Example of variable costs include:
- Staff commission and billable labor/freelance services
- Employee training, functions, gifts, and perks
- Marketing and advertising
- Raw materials
- Business income taxes
Estimate initial startup revenue
Your revenue is the sum total of your startup’s income from sales of your products and services. Revenue can be the primary source of funding for your budget, or you may receive support funding from sources such as venture capital, revenue-based financing, and debt.
Even if you’re primarily a venture-funded startup, your revenue informs on your conversion efficiency as a pointer to how much market share you’ve been able to capture with previous funding. This determines how quickly you can become profitable or how much your startup is worth when you’re raising funding or looking to get acquired.
There are two major revenue calculations for startups to keep in mind.
Monthly Recurring Revenue
Monthly recurring revenue is a monthly amount of incoming revenue that’s subscription-based or recurring in nature and highly likely to continue into the future.
The formula for MRR is to multiply your average monthly subscription value per customer by the number of customers. Multiply by 12 to get your ARR—your annual recurring revenue.
MRR = Average monthly subscription value X Number of customers
ARR = MRR X 12
Your revenue potential estimates how much income your startup can generate, judging by the addressable market for your startup’s product or service offerings. Revenue potential takes into consideration several variables such as:
- Total addressable market share
- Average conversion rate of customers
- Average sale per customer for your industry
Revenue = Total purchases X Total Average $ Per Purchase
Review and tighten your startup budget
With a rough outline of the revenue and expenses you need to factor into your startup budget, here’s where you fine-tune your budget for efficiency.
Adjust for market conditions and competition
Let’s assume a startup launches in a niche area with very slim competition. It immediately kicks off with a Google ads budget of $8,000 per month.
Over the course of a year, they’d have spent close to $100,000 acquiring their initial customers and creating brand buzz.
Perfect, right? Not exactly.
Given the volume of competition in their niche, it might have been better if that paid ads budget was slashed to save money and provide a longer runway. Given there’s little competition, the startup would have gotten similar results by investing in organic acquisition with lower costs.
On the other hand, imagine your startup has several competitors marketing aggressively with search content, Google ads, etc. In this case, you might need to bump up your marketing budget to stay visible alongside your competition.
While planning your startup budget, you need to carry out your due diligence with other departments like sales, marketing and HR to get a better picture of the competition they intend to face so you can determine how much to invest.
Determine between necessary & discretionary expenses
It’s a common theme in Startup Land.
A promising startup raises funding and immediately goes on a spending spree. Legal service subscriptions, overpriced advisors, consultants, and conferences that don’t add to their bottom line.
In a few months, cashflow is stagnant and they’re down to their last $10,000 - $100,000. Founder salaries are slashed, unnecessary expenses are cut, and a few employees get laid off.
Finally, the startup goes belly up and joins CB’s failed startup statistics.
Don’t make the same mistake.
Take a long, hard look at every expense to determine whether you really need to make it. And even if you need to, do you need so much of it?
A 4,000 sq. ft. office can serve just fine for your 10-20-person team until you get bigger. You can forgo costly conferences and ads on unproven networks (LinkedIn & Product Hunt, looking at you) until you have more revenue to experiment with.
Define what you need and what’s nice to have. Stick to what you need; postpone everything else until you have the cashflow or until it’s absolutely necessary.
Consider the timing of your spending
Spending $2,000 on a legal subscription may save you a lot of headaches for just $24,000 annually. But are you sure you need to spill that amount of cash in the first few months of your startup’s life?
Granted, there are certain expenses you need to start making at some stage of your startup’s life. But if you think long and hard, you might realize some spending can be delayed.
Some expenses you might consider holding off on include:
- Conferences. They’re a great way to build visibility in your industry but $25,000 spent on a TED ticket when you still have little cash flow might be a bad investment.
- Advisors. Bringing an advisor aboard can be rewarding and help you avoid a lot of potholes—as long as your startup is big enough to actually need an advisor. Otherwise, just keep growing until you need help shifting into a higher gear.
- Rewards. Perks can be a great way to motivate employees, but consider waiting until you can fund it for the long-term.
- Staffing and contract services. Before WeWork went belly up, they had contractors coming in to water their plants, while an employee would just follow around. Wonder what happened to them.
As a startup, it pays to create a budget tailored to your needs and to stick to it. But creating a budget is just one part of the startup finance equation. You need tools that empower you to control employee expenses and enforce your budget at the point of spend.
Using a spend management tool like Lola.com, you can take your budgeting to the next level and ensure only what’s necessary gets spent.
Lola empowers startups to:
- Issue payment cards to employees with budgets and dynamic limits
- Visualize, approve, or reject expenses in real-time
- Eliminate out-of-policy and over-budget spend
- Filter down spend data for greater visibility, and
- Manage cardholders with ease
Lola is designed to complete your startup budgeting with spend management that works. Not only do you get to plan expenses but now, you can limit individuals and departments to the amount they’re scheduled to spend per your budget.
Learn more about how Lola can transform your startup’s financial management.