How do you keep score in your business? How do you know if you are winning or losing? Is it money in the bank? Profits? Growth? The answer: “All of the above.” As such, budgeting is key to your operational and financial plan. But how do we formulate a common sense budget that is useful and is simple to understand and prepare? We start by understanding our vision. Knowing what you want to accomplish strategically is absolutely vital and measuring against this objective is paramount. A budget is your game plan.
KEYS TO A SUCCESSFUL BUDGET. Budgeting is nothing more than formulating a coherent financial plan for some period in the future, usually one or two years. As the plan is implemented, we are able to rate our efforts compared to the budget that we created. Budgeting allows us to predict the number of technicians, vehicles, equipment, etc., that we will need in the future, based on our revenue projections. The keys to successful budgeting are to create realistic sales and expense forecasts; make realistic goals based on your current income and expenses; and look at it often and adjust to achieve your goals.
Following are six steps to success:
1. Specify a timeframe. Budgets are prepared for a specific time period. They are often created for a year at a time, but you may also want to budget on a monthly, quarterly or semi-annual basis. Even if you prepare a budget based on a year, you should seriously think about breaking it down on a month-by-month basis. Accounting programs such as QuickBooks makes this easy by offering a variety of formatting options.
2. Create assumptions. Your assumptions are extremely important to the budgeting process. They should be listed as part of the budget document as you may have questions in the future as to where certain numbers come from. Consider the following assumptions when preparing your budget:
- What percentage growth do you expect in revenue? How much will you sell to existing customers? How much do you expect to sell to new customers?
- How many technicians or laborers will be in your organization, and what will they be paid (total direct wages)?
- What are your vehicle leases/payments, as well as total auto costs?
- What are your material costs? (This will be a function of your projected revenue previously noted.)
- For advertising costs — how many leads do you want and how much are you willing to pay per lead?
- What are your general and administrative costs, i.e., what will it cost to maintain the office, the functions performed in the office and the people to run the office?
3. Budget the gross margin. The gross margin concept is extremely important in that it allows a firm to understand how much business is needed to break even. Using the gross margin approach, a business owner can analyze his/her pricing strategy to determine if and how much profit can be made based on the current capacity of the firm (i.e., number of people and assets). The gross margin must be budgeted based on the service line (i.e., lawn care, maintenance, irrigation, etc.). Each service line will have a different gross margin.
4. Properly time your revenue and expenditures. It’s also a good idea to consider when income and expenses will be incurred. For example, if your firm is highly seasonal, most of your income will be received during the warmer months. Budgeting your annual income evenly over 12 months would not accurately reflect your situation. A much better approach would be to budget the income and expenses for the months you actually expect to receive or pay.
5. Use a line-item method. When you created your chart of accounts, you created a list of general categories such as various revenue types, office expenses or repairs and maintenance. When creating your budget, look at your chart of accounts and code your revenues and expenses in those categories. If you use QuickBooks, you can enter your budget into the program and produce actual vs. budgeted numbers reports.
6. Give budget authority to your employees. A critical element in delegation of work and authority is assigning responsibility for expenditures and bottom-line outcomes. At the beginning of each period, identify the amount of money budgeted for each area of your business and assign that area to a manager. Then, at each reporting period, check the results of their expenditures against the amounts budgeted and how that person did in terms of working within the budgeted amounts. Perhaps you can include an incentive program for those who come in under budget. Whether in the corporate world or the world of small business, it is human nature to spend all the money in the budget because there is always some piece of equipment to upgrade or replace. Put a price on resisting that urge, and don’t forget to explain all the reasons behind the budget decisions.
CONCLUSION. Know where you want to go in your business in terms of growth, profitability and timeframe. Make a plan. Reduce the plan to a line-by-line budget and execute on the plan. If you take these steps in the future, you should find that you have better vision, and you may avoid costly errors.
The author is a CPA and managing director of PCO Bookkeepers.
Article is reprinted, with the author’s permission, from PCO Bookkeepers.