When you hear the word “budget,” what is your first reaction? Most clients would say something similar to “Ugghh!” and would rather do just about anything besides create a budget. The word “budget” brings up connotations of endless numbers, constraints, and hard work; none of which are very desirable.
Yet, the benefits of a budget are huge. Budgets can help you with cash flow improvements, keep a business on track for higher profits, and draw attention to items that need further action. We’re going to let you in on some secrets that we use for our clients’ budgeting process.
From “Budget” to “Profit Plan”
To get started, let’s get rid of all of all the negative connotations that go with the word. Perhaps it might work if we rename “budgeting” to “profit planning.” And then, rather than focus on how little we should spend, let’s start our Profit Plan with how much revenue we’re going to make.
To create a simple revenue plan just go backwards. What is our revenue goal this year? Just like we would never get in a car without a final destination, a revenue plan gives us a number to aim for in our businesses. Often this is the prior year number with a growth factor added. For example- 2013 revenues + 12%.
Once we know the number, we can use averages and seasonality trends to come up with the monthly sales we need to generate in order to meet our revenue goal. Service providers may be slower in the summer due to vacations but busy at year-end when clients push to get projects completed. Construction companies revenue streams often look like a bell curve slightly skewed toward third quarter.
The next step is to estimate the costs to generate the revenues anticipated. This is actually a pretty simple step. We like to apply a percentage of Cost of Goods Sold based on prior years results and the expectations of the coming year. A client with Gross Profit of 30% means 70% is the cost of sales. If a business just rolled out a new, more profitable product or service, maybe we’ll decrease that COGS % a little.
Using a percent of sales also allows better comparison to actual results. We all know revenues are never exactly what we budgeted which makes using the dollar amount as our benchmark tough. But if we’re Profit Planning for 30% Gross Profit and our actual number is 32% or 28%, our clients have a much better idea if they’re on track.
Protecting Your Profit
Think of the expense side of the Profit Plan as protecting your profit margins to ensure financial gain from all the hard work. Setting limits on spending allows business owners to control overhead and keep more of what they earn.
Time Your Expenses
Not all expenses occur evenly throughout the year. Look at this example of a 12 month budget- this client anticipated some significant computer expenses in August/September, a major website upgrade in June and a spike in insurance cost during July/August. This allows management to evaluate the impact of these decisions and possibly defer some expenditures if warranted.
A great “profit plan” report will provide several things. We can compare budget to actual and be alerted to the accounts varying from expectations. It also allows us to anticipate upcoming cash needs as shown in the above example. Finally, using actual results YTD and adding in the remaining months on the Profit Plan is a great way to predict how the year will look.
A “profit plan” is a great tool for your business. If we can help you with the process or provide you with custom reporting, please give us a call.