Many small business owners make the mistake of picking some arbitrary percentage and calling it their budget. “We’re going to grow 5% next year.” Or, “We’re planning on hitting our 10% target”. They do this without answering why? Why do shoot to grow at this particular percentage? Most of the time, the number is just a figure spoken so they can claim they’ve put a budget together. You may be surprised at how many business owners randomly select a growth number with no clue if it’s in fact the right number.
Let’s break down a five-step process that shows you how to develop your small business budget. For entrepreneurs, this is going to set you on the path of being able to budget the proper way, every year, for your business. And for those of you who aren’t business owners, after you read this, you’ll likely be able to budget better than your boss. I promise you.
Here’s the five-step process to plan your next year with confidence.
Step 1: What Is the Market Doing?
You don’t start with the growth rate you just happen to desire for your business. You start with the market you compete in. And if you’re a small business, you have to go a layer deeper than the national numbers by understanding your local market.
A few things to consider:
Identify how fast your market is growing this year. Say you’re in HVAC or some type of construction business. You might have to go to your local city hall business office, look through the permits, and see how many are being issued for the next year. That tells you how much HVAC material is going to need to be installed or serviced. This example shows you may have to dig to figure out what’s happening in your market, because national trends may not reflect what’s happening locally.
If your industry has trade associations, they likely produce some sort of publication. Use these to see what’s going on in your industry and specific market. You can usually pick out trends that way.
Also factor in inflation. Inflation averages about 3.5–3.7% a year. If you’re not growing above the rate of inflation, you’re losing money. No matter what, you need a plan to grow at least at the rate of inflation.
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Step 2: What’s My Alpha?
Once you know what the market is doing, the next question is: what percentage do I want above the market trend? That’s your alpha.
You have to think about how you’re going to accomplish that. If we keep everything the same and the market’s going at 5%, we should expect to grow at about 5%. To get more than that, we have to actually do something. We’re not getting that extra gain by accident.
If we’re growing faster than the market, that means we’re taking market share. If the market’s at 5% and we want to grow at 10%, that extra 5% is coming from one of your competitors. You must be deliberate and aggressive to go get it. Because of the nature of business and competition, I recommend you always stay aggressive and always try to outdo the market.
You have to be mindful of where this growth is coming from. Is this coming from new customers? Is it taking existing customers from competitors? Is it capturing a larger share of new customers entering the market? What’s your strategy?
Business as usual will not get you there. You have to be deliberate.
Step 3: What’s the Investment Required to Get That Alpha?
What’s it going to take? New salespeople? New equipment? New software or efficiencies that free up your employees’ time to be productive elsewhere? Are you going to offer more products or services to your existing customers and charge more for the same services?
However you plan to achieve that extra 5%, this is how you build the budget around it. You need to identify the required investment. Specifically:
How many salespeople, at what rate, and what are we planning to pay them?
If it’s new software, what is that software actually going to do? How does it impact our current customers? What’s the increase in margin on the additional products we’re going to offer them?
Whatever it is, you have to figure it out, define it, and make it part of your plan.
Step 4: Your CapEx
This is different from the investment you’re putting in to chase market gain. You have to separate the two. Capital expenditures are the required reinvestment in your business to keep the business operating. This may be vehicles or heavy equipment for transportation and manufacturing. Or it could be needed furniture and printers for your office space.
These aren’t necessarily large expenses but the ones that are needed to operate. It might not technically qualify as a capital expenditure on the books but you still have to include it in your budget.
These are costs required no matter how great or how poor your business performs. You’re going to spend this no matter what, so keep that bucket separate from your investment bucket.
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Step 5: Your SG&A
Lastly, your selling, general, and administrative expenses are considered. The expenses required for your business that don’t directly result in income. Your administrative staff. Lease or rent. Utilities. Other recurring costs. Training, licenses, dues, subscriptions, networking events or organizations you’re part of.
A lot of these are recurring and probably won’t swing much year to year, but there’s one thing you need to think about: you want the tenure of your people to be longer than usual. You want them to stay, and you want them happy. So factor in raises and bonuses for your admin staff. Don’t ignore the people keeping your business operating by answering phones and handling customer complaints. They may not be the ones out there bringing in the money, but they’re just as important. Include that increase, assuming you’re performing well enough to support it.
Once you’ve considered that, you’ve pretty much built your budget.
Quick Recap
Start with the market trend.
Decide how aggressive you want to be and what reasonable target you can actually reach with real investment into the business.
Go through your CapEx → what you’re reinvesting just to operate and to keep the doors open and everything functioning.
Then your SG&A → your overhead and admin, which a lot of people miscalculate.
Once you’ve done all of that, you should land at your desired margin. Whatever your profit margin target is for your industry (manufacturing, construction, and building materials tend to run lower margins; service and tech businesses tend to run higher) make sure your budget has you landing where you want to be. That way you can track what’s working and what’s not.
Why You Have to Identify the Investment Upfront
One thing worth expanding on: when you’re investing in the business to capture market share, it’s important to identify that investment clearly so you can actually measure its effectiveness.
I’ve seen this constantly in the corporate setting. Budget-to-actual meetings where you have to explain why you didn’t hit budget, or why you went over in certain expenses. And a lot of times it’s hard to answer because nobody identified upfront what they were actually doing differently to reach that market gain.
Say you were targeting 10% and you landed at 8%. Why? “Because we grew 8% instead of 10%” is often the best answer available. Nobody tracked what new equipment went in the business, or that you hired two salespeople and what they were actually producing. If you had identified that upfront, you could look at their progress and see how much business they’re bringing in, and that becomes your explanation for why you’re short of 10%. Do they need more training? Do people need better training on the new equipment? What’s the real issue?
Without identifying the investment upfront, you can’t do a real budget-to-actual analysis. That analysis is how you understand whether you’re hitting your benchmarks and why. Without it, the whole exercise doesn’t mean much. Identifying your investment up front will eliminate all of this confusion.
Why Small Businesses Need a 3-Year Rolling Budget — Not 5, Not 10
A lot of large companies run 5- or even 10-year trend projections to see where they think they’ll land. As a small business, agility is your advantage. It’s the thing you can do that a company the size of Apple or Google can’t. No matter what industry you’re in. Large businesses simply can’t shift as fast as you can.
In my opinion, a small business needs a three-year rolling budget. Not five years. Not ten. There are too many changes occurring in that timespan. Think about how much AI has impacted everything in the last five years, and things are still changing. What do you think happens over the next three?
So build a three-year budget. If you’re planning for 2027, you’d estimate market trends for the following two years as well, through 2029. Then, once 2027 wraps and you’re heading into 2028, you extend the budget out to 2030, adjusting for what you actually accomplished in 2027 and what you now expect for 2028 and 2029. That rolls forward every year. You update it annually, and depending on where you are, you might revise those outer two years to stay realistic.
Be Reasonable, But Don’t Be Average
Budgeting isn’t about hitting a random number. You want to challenge you and your team to keep growing the business, but it has to be reasonable. It’s not about saying “10%, 15%” just because, with no real plan behind it. Even when you’re being aggressive, make sure the investment behind it makes sense and is something you can actually achieve.
Without that, you can kill morale fast! Setting a 20% budget increase with no plan, and then people are chasing a number that was never realistic to begin with. Especially when their compensation such as bonuses and raises are tied to it.
It has to be realistic. You owe that to your staff, and to yourself, to set something you can actually accomplish with the right, reasonable effort. Don’t set a budget you have to kill yourself to hit. Don’t set goals that wreck morale. Set reasonable budgets with reasonable investments that you, as the owner, can hand off to your staff so they can get it done with training, mentoring, and coaching behind it. Don’t just hand it off and walk away. Stay involved, make sure they have the support they need to reach it.
That’s my five-step plan to budgeting for your small business. Use this process as a template to help you set your objectives more accurately and reach your goals.
Whatever the market is doing, add your percentage to it if you can. And if you’re honest with yourself and you’re just not in a position to put real investment behind growth this year, that’s okay to say. If the market’s doing 5%, maybe the best you can do this year is 5%. I get it. Some people are in that position, and it’s better to be honest than to chase a challenge you can’t actually meet.
But for those of you in a better position, be aggressive. A company that isn’t growing is a company waiting to fail. You’re waiting for a more aggressive competitor to show up, or for someone to figure out how to utilize technology better than you and push you out. Business is competition, no matter how comfortable things feel right now. You have to stay aggressive and stay ahead.
Let me know what you think about this budgeting process in the comments. See you in the next one.
Carlos McWhorter, CPA is a fractional CFO consultant specializing in helping founders transition to CEO of their company, becoming an effective manager instead of the primary contributor.
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