This article is part of our “Business Startup Guide” – a curated list of our articles that will get you up and running in no time!

An expense budget is part of the bread-and-butter basics of good management. Set your budget as a goal, then review and revise often to stay on track. Being right on budget is usually good, but good management takes the regular review to check on the timing, efficiency, and results of what your business spends.

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For the record, we could call it an expense forecast, or projected expenses. Those are the same thing. And regardless of what you call it, when you combine it with projected sales and costs, you have what you need to project your profit or loss.

Expenses make up just one of the three common types of spending in a normal business. The first is costs, also called direct costs or costs of goods sold (COGS), what you spend on what you sell.

For example, the COGS for a bookstore are the costs of buying the books it resells to its customers. Those go in your sales forecast.  The second is your expenses. They are mostly operating expenses, like rent, utilities, advertising, and payroll. That’s what I’m talking about in this article. The third is what you spend to repay debts and purchase assets. That money affects your cash flow and your balance sheet, but not your profits. And that’s not included in this article.

Your expense budget

It’s all about educated guessing. Don’t expect to accurately guess the future. Do use your experience, educated guessing, a bit of research, and common sense to estimate expenses in line with sales and costs and your planned activities.

The math is simple

The illustration here shows a sample expense budget from the same bicycle business plan I used in the previous article how to forecast sales.

The math and the logic is simple. Make the rows match your accounting as much as possible. Set timeframes and estimate what expenses will be for each of the next 12 months, and then for the following two years as estimated annual totals.

Expense Budget

In the example, Garrett—the bicycle store owner—knows his business. As he develops his budget, he has a good idea of what he pays for rent, marketing expenses, leased equipment, and so on.

And if you don’t know these numbers for your business, find out. If you don’t know rents, talk to a broker, see some locations, and estimate what you’ll end up paying.

Do the same for utilities, insurance, and leased equipment: Make a good list, call people, and take a good educated guess.

Payroll and payroll taxes are operating expenses

Payroll, or wages and salaries, or compensation, are worth a list of their own. In the case of the bike shop owner, for payroll, he does a separate list so he can keep track. Payroll is a serious fixed cost and an obligation. Garrett’s summary budget (above) has the one line for payroll, but it comes from a separate list. He just takes the total into the budget. Here’s the list:

Payroll Budget Example

Notice that the totals from the Personnel Plan show up in the expense budget. And you can see the estimated benefits expense over and above the gross salary. Garrett uses “Benefits” as a blanket term; it includes payroll taxes along with what he spends on health insurance and other benefits.

Don’t worry too much about depreciation

Depreciation is a special case. Traditionally it counts as an operating expense, but a lot of businesses budget for it separately because it doesn’t actually cost money.

It’s a concept the tax code allows us to deduct as a business expense, in theory to allow for the gradual decline in the value of an asset, or—depending on which expert you follow—to allow money to buy new assets when existing assets become obsolete.

The argument for including it in the expenses is that it gives a more accurate picture of profits. And many people separate depreciation from the other expenses so they can calculate EBITDA, which is earnings before interest, taxes, depreciation, and amortization (which is like depreciation, but for intangible assets).

Bottom line: Include it or not; it’s your choice.

Yes, interest expense is an expense

Because interest is also excluded from EBITDA, many people also exclude it from operating expenses. They list it separately, along with depreciation, to make the EBITDA calculation easier. I say you can do that either way, it doesn’t matter, as long as you include the interest expense in your budget. Because, unlike depreciation, interest does cost money.

Remember the underlying goal

The purpose of the budget is good decisions. Set expenses to align with your strategy and tactics, so you do what works best for your long-term progress. Match your accounting categories as much as possible, so you can track later. Keep track of assumptions so when things come out different from plan—and they always do—you can adjust quickly.

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Tim BerryTim Berry
Tim Berry

Tim Berry is the founder and chairman of Palo Alto Software and Follow him on Twitter @Timberry.